The complexities involved with setting up an auto-enrolment pension scheme have been such that some employers have inevitably failed to grasp every detail of their new arrangement.
One particular area in which we are finding there is still a great deal of confusion concerns the basis used to give the tax relief on employee contributions.
For no particularly good reason – other than the government’s inability to find a unified solution – there are two different approaches used.
Occupational pension schemes (including those labelled as “master trusts “have the ability to operate on a ‘net pay’ arrangement, which means that contributions are collected from pay before Income Tax is worked out, and employees automatically receive their full amount of tax relief at outset.
Other schemes, such as group personal pension schemes use ‘relief at source’, with the employer taking 80% of an individual’s pension contribution from their take-home pay. Basic-rate tax relief is reclaimed from HMRC by the pension scheme administrator and added to the pension plan, with higher-rate and additional-rate taxpayers being left to reclaim any further tax relief due from HMRC themselves.
We find that relief at source, which can be used in conjunction with salary exchange, tends to be most popular with companies we deal with.
But both types of arrangement have their pros and cons, and there are few hard and fast rules as to which will be most appropriate for any particular type of organisation.
However, relief at source may best suit those with a high proportion of very low earners. This is because with a net pay arrangement employees who don’t pay tax, or who don’t have sufficient taxable income don’t enjoy any tax relief from the government on their pension contributions and those who don’t have enough taxable income to cover their contributions to the pension scheme will only receive partial, not full, tax relief.
With relief at source, on the other hand, non-taxpayers end up better off because they enjoy tax relief at 20% even though they may have paid no tax.
Those individuals affected by this discrepancy tend to have limited knowledge of the tax system and of pensions in general, so they probably won’t know that they might be worse off under net pay.
They are therefore unlikely to broach the subject with their employer. But it would undoubtedly help if they were able to because far too many employers simply don’t know which approach is being used by their own pension scheme!
Some may have originally ticked a net pay box on their application form without understanding what they were doing.
We have certainly received a number of enquiries from clients who had taken out their scheme via a previous intermediary and were not aware that they were operating a net pay arrangement. The situation invariably ends up being a real mess.
In some cases employers using net pay have even been deducting employee contributions from payroll net of basic rate tax. As well as having to make the appropriate refunds, these employers also have to deal with the fact that contributions have been below the mandatory auto-enrolment minimums.
The whole issue has of course grown in importance during recent years as a result of auto-enrolment creating huge increases in the numbers saving in pension schemes – particularly of lower earners.
So, the key message for all employers is that they should at least ascertain what basis for giving employee tax relief they are using.
If you do not feel entirely comfortable with the approach you have in place then please contact Chase de Vere and we will be happy to advise on whether it is the most appropriate one. In certain cases this may result in us switching you to a new scheme.
If employers are not proactive in this respect they are only risking creating an even bigger shambles that needs to be sorted out further down the line, and it is unlikely that government will be issuing any reminders or providing any immediate solutions to the problem.
The Conservative Party’s 2019 election manifesto did include a commitment to revisit this issue, and there was a call for evidence following Rishi Sunak’s mini- Budget this July. But no-one should be holding their breath as COVID-19 and Brexit have given politicians much bigger fish to fry.
Content correct at the time of writing and is intended for general information only and should not be construed as advice.