Tax relief for members of workplace pension schemes can either be on a ‘Relief at Source’ or ‘Net Pay’ method.
Both allow members to benefit from tax relief and it is the methodology which differs, often according to the type of workplace pension. Broadly speaking, contract-based schemes, such as stakeholder and group personal pensions work on relief at source and trust-based pensions such as Master Trusts work on net pay.
Relief at source pensions work so that all member contributions are collected net of basic rate tax and this deduction appears on the right-hand side of a payslip (i.e. after tax and National Insurance have been deducted).
The workplace pension provider then automatically claims tax relief for the member’s pension from HMRC and add the tax relief to the member’s pension contributions. This happens automatically.
In basic terms, this means a £100 member contribution is paid as a £80 deduction from their pay after other deductions and the pension provider adds the £20 automatically.
Hence, the basic rate tax relief is added automatically to every member’s pension, even if they do not actually pay tax. It is popular with employers where several of their employees earn below the tax threshold and/or work part-time.
Net pay arrangements are paid differently in that the whole member contribution is paid gross and is shown on the left-hand side of a payslip (i.e. before tax and National Insurance have been deducted). This means a £100 member contribution is paid in full by the employer.
Relief at source contributions are paid from net pay and net pay contributions are paid from gross pay. Confused? You should be.
Apart from the seemingly back-to-front descriptions used, the problem with a net pay arrangement is that any employees who are earning less than £12,570 (the current threshold for basic rate tax) will not receive tax relief on their workplace pension as they do not earn enough to pay tax.
This anomaly has existed for years and, not before time, the government announced in July, they will pay a top-up to low earners making contributions to pension schemes using a net pay arrangement from the 2024/25 tax year onwards.
HMRC will notify those who are eligible and invite them to provide the necessary details for the top-up to be paid directly to their bank account.
Finally, lower-earning employees should receive identical outcomes regardless of which type of workplace pension they have.