Govt outlines solutions for pensions net pay anomaly

The Treasury on Tuesday published a 40-page call for evidence, which presents four options being considered to address the difference in outcomes between members of ‘net pay’ and ‘relief at source’ pension schemes.

Members of relief at source pension schemes are granted basic rate tax relief of 20 per cent on pension contributions up to £2,880 a year, even if they do not pay income tax due to low earnings. In practice, this means HM Revenue & Customs will top up a net contribution of £2,880 to a gross £3,600.

However, these schemes are only accessible through a handful of companies. The more common net pay schemes do not offer access to such tax relief.

The four solutions outlined by the government in this consultation seem too complicated, and the idea of moving all DC schemes to RAS feels like an extreme fix for the scale of the problem

Mike Ambery, Hymans Robertson

To align the tax treatment for those contributing to pension schemes with the same incomes but using different methods of tax relief, the government is exploring four methods.

The first involves HMRC paying a bonus to lower earners who are in net pay schemes, to put them in the same position as lower earners who are members of relief at source schemes.

Under this proposal, the tax authority would use the current end-of-year process to identify those who contribute to a net pay pension scheme and have total income below the personal allowance. 

HMRC would then provide them with a payment equal to the basic rate of tax on their contributions. 

But the government has said it is “unlikely to proceed with this proposal” as it introduces additional complexity for members, pensions schemes and HMRC, and would require costly administrative processes. There would also be a sizeable time lag between the pension contributions being made and the bonus received.

Govt short of attractive options

Another proposal was for HMRC to apply a standalone charge to recover the top-up given under the relief at source method — effectively levelling down those who currently have an advantage.

The government is also against this proposal as it would mean taking money from some of those on lower incomes who are saving for their retirement.

The paper stated: “Further, it would not, by itself, equalise outcomes as a [relief at source] saver would still have a lower personal allowance than a member of a net pay scheme.”

One approach that the Treasury has said could work on a voluntary basis would see employers provide two schemes for their employees: one net pay and one relief at source.

It warned the approach required close working relationships between the employer and their payroll and pension providers to set up the necessary systems to automate the “switching” process. 

But it has also been suggested that once the initial implementation has been completed the burden would be manageable.

The consultation stated: “The government would welcome evidence relating to the costs of this approach (including pension scheme operator fees and payroll costs) to assist in its evaluation.”

The end of net pay?

A more radical approach would be to require all defined contribution schemes to operate on a relief at source basis.

Different versions of this proposal include requiring all employers with low-earning employees to use relief at source DC pension schemes, all new DC schemes to use relief at source (and removing the option to apply to operate net pay), or for all DC schemes to move to relief at source arrangements.

The government said this method is attractive for introducing a single method of tax relief for some or all DC savers. “The government recognises that there would be many changes required to scheme and payroll processes,” it said.

“There may also be a need for employers to review employment contracts to fully understand the impacts for their employees.”

The executive summary stated: “To date a proportionate and straightforward solution to address the difference in treatment for low-earning pension savers has not been found. There is a balance to be struck between ensuring consistency in outcomes and ensuring simplicity for individuals.

Action ‘overdue’

The pensions industry, meanwhile, has its own thoughts on the appropriate methodology for righting this injustice.

The Net Pay Action Group and the Pensions and Lifetime Savings Association suggested in a February letter to the Treasury that HMRC could adjust the P800 process for calculating tax over and underpayments to automatically collect real-time information on contributions and salary, allowing top-ups to be made. However, legislative change is needed to implement this solution.

Lizzy Holliday, head of DC, master trusts and lifetime saving at the PLSA, said: “The publication today by the government of a call for evidence on the net pay/relief at source issue shows long overdue progress towards fixing the tax anomaly that is leaving 1.75m of the lowest-paid pension savers in ‘net pay arrangements’ worse off.

“On the minimum auto-enrolment contributions, those affected are losing up to a total of £63 a year each, and in many schemes it can be at least double this figure. Of the affected population, more than 75 per cent are female.

“The PLSA has long advocated for the P800 solution using Real Time Information data as the best option to addresses the issue, and we will continue to engage with the government regarding the barriers they have posed — action is needed on this matter,” Ms Holliday continued.

Given the complexity involved in any of the options the government has explored, some have suggested that a root-and-branch reform of tax might provide better value for money.

Michael Ambery, head of DC provider relations at Hymans Robertson, said: “While we are supportive of this issue being addressed, any solution needs to be put in context of the overall £40bn tax relief bill.

“It’s a fiendishly complex issue to address and the government needs to take care that it doesn’t adversely impact the wider tax-relief processes. The four solutions outlined by the government in this consultation seem too complicated and the idea of moving all DC schemes to RAS feels like an extreme fix for the scale of the problem."

Mr Ambery added: “We know that there will not be a ‘perfect’ solution to addressing this issue, but more must be done. What’s really needed is a full and fundamental review of the whole tax relief system, similar to what was abandoned by George Osborne in 2016.”

The call for evidence closes to responses on October 13 2020.

This article originally appeared on ftadviser.com. Additional reporting by Angus Peters