It came to our knowledge last week whilst we were handling company pension reviews for 2 clients. That there is a pension loophole that is putting many lower earners at a dis-advantage when it comes to tax relief.
When you pay into a pension scheme directly you get basic rate tax relief at source at 20%. Example, if you pay in £80 per month into a pension, it is immediately made up to £100. If you pay in £100 net, it is made up to £125.
When your employer pays in, there is no tax relief added as your employer can offset their payment to your pension as a business expense against corporation tax, or if a self-employed boss, income tax.
If you are an employee and a member of a company pension scheme with payments deducted from your wages before you receive them. Your pension contribution is usually deducted from your gross pay before tax, and then you pay tax on your ‘net pay’ i.e. a lower amount. This is known as a ‘net pay arrangement’ as you do not get tax relief added by the pension company because you already received it indirectly pay only paying taxes on your lower income after the pension contribution was made.
For example. your earn £1000 and have £100 deducted from pension. If you are in a net pay pension scheme, the £100 is deducted from your pay before tax so you only pay income tax on £900 (i.e. a NET PAY scheme). This compares to any normal private pension, where you would pay income tax on your full £1,000 pay (a GROSS PAY scheme) i.e. more tax is paid from wages and then when you pay £100 into your pension, you get tax relief added.
But what if you are a low earner, earning less than £11,800 pa (the personal allowance tax threshold) and you have a net pay arrangement pension at work? Your pension contribution is deducted from your wages and then income tax is applied. But, you pay no tax anyway! And you are not then getting tax relief on your pension contribution. Unless you know this and know that you should approach HMRC, you will not get tax relief.
HMRC are looking to try and address the problem.
Another Net Pay Risk to Watch out for .....
In another example for a company pension this week, HMRC and the pension company had the pension scheme logged as a ‘net pay arrangement’ i.e. no need to offer tax relief as pension payments were deducted before income was taxed. In this particular, the employer was deducting pension payments from pay after income tax it was a ‘gross pay’. In short, the employee was getting no tax relief at all.
By way of a final example, another was paying into a net pay arrangement, where not further tax relief is to be given as employees have already had it, by paying tax on a lower ‘net’ wage (after pension deduction) and the employee was then putting these pension contributions through their tax return and claiming further tax relief. Effectively getting double tax relief.
What are we saying here?