Pensions tax relief – is it all going horribly wrong?

When I’m lecturing to agents and employers, naturally the subject of pensions tax relief comes up and particularly the interaction with salary sacrifice (or optional remuneration arrangements as we must now call them). It’s also becoming a focus for HMRC and The Pension Regulator.

So, let’s deal first with straightforward tax relief on employee pension contributions. Calling schemes that provide tax relief by the reduction of gross taxable pay, ‘net pay arrangement schemes’ was always going to be problematic when you had thousands of employers new to pensions. It sounds like it’s to do with net pay when it’s the opposite. It doesn’t necessarily solve the problem if you have a payroll agent, remember many payroll bureaus had never been involved with pensions before auto-enrolment, their pensions’ exposure was probably limited to deducting a fixed amount from net pay for a personal pension at the odd owner managed business. Suddenly tiny clients needed to tell them what type of tax relief they were operating, and at times it was probably like the blind leading the partially sighted. This now appears to be coming back to haunt employers and agents. With around 40,000 live pension schemes in the UK, if only a tiny proportion of schemes and members are getting the incorrect version of tax relief, the employer, employee and HMRC have a problem.

Putting to one side (and that’s not to underplay it as it’s a disgrace) the inequity of net pay arrangement schemes for non-taxpayers, versus those in Relief at Source. Let’s consider all the possible variants that employers need to understand to set up payroll correctly or brief their agent:

  • Net pay arrangement (NPA): gross pay for tax reduced by the employee’s pension contribution, pay for National insurance purposes and student loans not reduced
  • Relief at source (RAS):
    • Deduction of contributions from net pay at the employee percentage in the scheme rules, where the employee has no national insurance number (NINO) this must be the amount deducted, as there will be no eventual tax relief claimed for employees without a NINO, or
    • Deduction from net pay with the correct employee percentage reduced by 20% to allow for the eventual minimum tax relief that the scheme will reclaim

Turning our attention to salary sacrifice, and things get worse…

In a pension salary sacrifice there are no employee contributions, it has become a non-contributory pension scheme. That’s why the regulations have never required an employee minimum contribution. The employee has given up salary in exchange for an enhanced employer pension contribution.

  • Giving up the salary is what reduces tax and national insurance, assuming the employee earns enough to pay either or both. It is not tax relief and it certainly isn’t NI relief!
  • The payslip must not show employee pension contributions as there aren’t any
  • The gross pay side of the payslip can show a reduction in pay for pension contributions, but it should not reference that they are employee contributions, as that undermines the contract that says pay has been given up in exchange for the enhanced employer contribution
  • The file that is sent to the provider should not have any employee contributions shown, if it does the provider will improperly claim tax relief if it is a RAS scheme

How many legacy platforms insist on an employee and employer contribution even if there is a sacrifice in place? – I know of at least one very large pension scheme that still does and I’m sure there may be many more. This is the next big compliance issue lurking, and just when we thought we’d got auto-enrolment sussed……