RP Case Study: Tax relief or tax deferral?

Is “there is no tax relief but only tax deferral” fake news? Here, Peter Hopkins examines the various taxable outcomes of whether an employee puts £100 into a pension, the employer does it for them, or the employee keeps it as salary

I’m old enough to have been fascinated by the moon landings as current affairs rather than history and to have wanted an Airfix Saturn Five. In that era, news outlets controlled the flow of information and the ‘truth’ was easier to determine. A lot of years lived later it has been fascinating to see how the information age has morphed into the disinformation age where the truth, myths and other variations of fake news all vie for air time.

This is equally true in the pensions sphere, and one of the myths that gets a lot of air time is; “there is no tax relief but only tax deferral”.

I’d like to explore that.

For the purpose of this endeavour, we’re going to assume we have someone of pensionable age being paid a pension contribution in the last month of a tax year and withdrawing it as a pension payment in the first month of the next tax year. I’m therefore ignoring the tax-free capital growth and tax-free dividends that can also attach to pension saving.

Case Study

The question is this: An employer gives the choice between £100 into a pension or £100 to the employee. The employee then has the choice to keep the money or to invest it in the pension themselves. We therefore have three scenarios: £100 as salary, £100 employer contribution and £100 employee contribution (the latter is paid via a net pay arrangement). What produces the best outcome?

For each we could assume several combinations of tax rates between being employed and taking a pension. To keep it manageable I’m going to consider three – 1) higher rate employee, basic rate pensioner; 2) basic rate employee, basic rate pensioner; 3) basic rate employee, non taxpaying pensioner.

This gives us a total of nine outcomes:

Higher Rate Employee, Basic Rate Pensioner

£100 salary: Costs employer £113.80. Employee receives £58.

£100 employer contribution: Costs employer £100. Pensioner receives £85.

£100 employee contribution: Costs employer £113.80 and employee £2. Pensioner receives £83.

Basic Rate Employee, Basic Rate Pensioner

£100 salary: Costs employer £113.80. Employee receives £68.

£100 employer contribution: Costs employer £100. Pensioner receives £85.

£100 employee contribution: Costs employer £113.80 and employee £12. Pensioner receives £73.

Basic Rate Employee, Non Taxpaying Pensioner

£100 salary: Costs employer £113.80. Employee receives £68.

£100 employer contribution: Costs employer £100. Pensioner receives £100.

£100 employee contribution: Costs employer £113.80 and employee £12. Pensioner receives £88

I think this shows mostly that you pay less tax if you save in a pension. If you are not paying tax and do not pay national insurance then it is possible that there is no tax to save or defer. However, these people will be in the minority, and if they pay into a ‘relief at source’ scheme as a member they can have a government top-up of 25p for every £1 contributed up £2,880.

For the rest this tells us three things – employer contributions are the most efficient all-round solution; the tax free lump sum is in itself tax relief; contributing while being taxed highly and withdrawing when taxed at a lower rate is also a good strategy.

But most of all, the government encourages both employees and employers to save for employees’ retirement. And if you save money in your pension, that money will be taxed less in retirement than if you were given it now. It is not simply tax deferral.

Peter Hopkins is technical resources director at AJ Bell