Auto-enrolment was considered an important protection for lower paid workers when it was first announced a few years ago. Now that the vast majority of companies addressed by auto-enrolment have complied with the law, there is growing concern that the same people helped by auto-enrolment are now being hurt by unfair application of pension tax relief. A number of accountancy news stories reveal calls for the government to change things.
At issue is how tax relief is reclaimed. Under one method, known as the net pay arrangement (NPA), lower paid workers may be losing out on basic pension tax relief due to them not paying income taxes. Under a second method, known as relief at source (RAS), all pension members enjoy basic tax relief whether they pay taxes or not. Higher income earners are forced to file self-assessment returns to get back any additional tax relief due them.
Tax Relief and NPA Arrangements
The NPA model has been used for years by public sector pension schemes. It has recently been adopted by private pensions in response to auto-enrolment requirements. This is where the inequities lie.
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An NPA arrangement requires nothing from pension-enrolled employees to take advantage of tax relief. Pension contributions are deducted from pay prior to tax being assessed. The scheme operator bears the responsibility of claiming back tax relief at the highest possible rate.
This model is all well and good for employees who pay income tax. But the lowest paying employees, those who do not pay income tax, don’t get back the 20% tax relief due them. Why? Because an NPA arrangement only applies when taxes are being paid.
Tax Relief and RAS Arrangements
An RAS arrangement is deemed more fair because it applies the basic rate tax relief to all enrolled pension members regardless of income and taxes. This arrangement relies on deducting pension contributions net of basic rate taxation. The 20% tax relief afforded under this arrangement is claimed back by the pension administrator.
Low- and high-income earners alike benefit from basic rate tax relief under an RAS arrangement. It is applied across the board, regardless of whether or not an employee pays taxes. The downside is that only the basic rate is applied. Earners with higher incomes eligible to receive more tax relief have to request it themselves.
Addressing the Inequities
It should be noted that neither arrangement applies to salary sacrifice schemes for purposes of tax relief. Such schemes have their own tax implications. Having said that, it is not quite clear how proponents of tax fairness expect the government to fix things.
One option would be to mandate RAS arrangements for all. Such a solution would probably not sit well with high income earners for obvious reasons. However, there is a second solution: instructing HMRC to use PAYE data to track those employees whose pensions operate under an NPA arrangement. Those employees could then be given tax relief through one of several different reconciliation methods.
It isn’t clear whether or not the government will respond to calls to make pension tax relief more fair. One thing is for certain though: a failure to make changes will only make the current inequities larger over time. For every percentage point tax relief increase, those obtaining tax relief through RAS arrangements will be getting more money than those stuck under NPA arrangements.
Auto-enrolment has been deemed a success by the powers that be. But the very people helped by auto-enrolment are now those being hurt by unfair tax relief. Hopefully that changes in the very near future.