Low earners in net-pay schemes will lose out on more pensions tax relief as the gap between auto-enrolment (AE) qualifying earnings and the personal tax allowance widens.
Under plans announced by the Department for Work and Pensions (DWP) today (4 December), the lower earnings limit for AE is set to rise by £104 per year to £6,136 from April next year.
Pensions and financial inclusion minister Guy Opperman also confirmed that the upper earnings limit will rise from £46,350 to £50,000, while the £10,000 qualifying trigger is unchanged.
As the Treasury confirmed in its budget on 29 October, the personal tax allowance will rise from £11,850 to £12,500, while at the same time, savers in net-pay schemes who earn less than the allowance will see additional contributions of up to £546 miss out on tax relief.
This is because, in net-pay schemes, tax relief is not applied to those who do not pay tax; conversely, those in relief-at-source schemes are granted a basic rate of 20% tax relief regardless of whether they pay tax or not.
Chancellor Philip Hammond has been urged to address the “anomaly”, and HM Revenue & Customs said, in October, that it was “looking at opportunities” to fix this.
AJ Selby senior analyst Tom Selby said the problem looks “set to get worse before it gets better”, noting the “tax injustice” will continue until HMRC implements new digital systems.
“Over a million people in net-pay schemes are already thought to have been affected by this anomaly, which robs them of the valuable tax relief they are entitled to when saving in a pension,” he said. “It is particularly cruel that this flaw in the system affects the lowest earners.”
In a written statement to the House of Commons, Opperman said the “main focus” when reviewing the limits was to “ensure the stability of the policy” during the increase in total contributions from 5% to 8% at the same time.
“We also want to ensure that our approach continues to enable individuals, for whom it makes economic sense, to save towards their pensions whilst also ensuring affordability for employers and government,” he continued.
£5.5bn increase in pension saving
Next year’s contribution rate rise is predicted by the DWP to result in a £5.5bn increase in pension saving, with £2.8bn of the increase coming from individual contributions. Meanwhile, the overall effect of the introduction of AE will see an increase of £18.4bn in annual contributions compared to 2011/12 levels.
When the impact of the 2019/20 threshold changes is also considered, the DWP estimates an additional £209m of saving compared to 2018/19 level, with £100m coming from employees.
Maintaining the qualifying trigger at £10,000 will also mean a further 40,000 people are brought into the AE regime, the department added.
The difference between relief at source and net pay
Under the relief-at-source method, pension contributions are deducted after tax is calculated, and HMRC then sends tax relief back to the scheme at the basic rate of 20%, which is then added to all employees’ savings.
However, under the net-pay method, pension contributions are deducted before tax is calculated, and savers receive tax relief directly based on their marginal rate. This means that savers who earn under the £11,850 tax threshold do not receive the 20% relief they would through their employer in a relief-at-source scheme.