Low earners in a net pay pension scheme will receive the same level of tax relief as those in a relief at source scheme from 2025, the government has said. Is this enough to improve pension taxation, or do we need wider simplification? 

 

The government published new legislation to fix the so-called ‘net pay anomaly’ on Wednesday, after extensive lobbying by industry. Pension savers currently earning less than £12,570  a year will receive similar top-ups to those earning more regardless of what tax arrangement their pension scheme uses.  

 

Beneficiaries will receive their top-ups directly into their bank accounts from 2025, and HMRC will be notifying those who are eligible then, according to the government, which has pledged “to deliver these changes in full and on time and will ensure the complex nature of these IT changes are ready to deliver this wide-impacting change”. 

 

 

The tax problem has been arising since 2015 because there are two ways in which employers and schemes can apply tax deductions on pension saving. In a net pay scheme, pension contributions are – somewhat paradoxically, given the name – taken off employees’ gross salary, meaning those earning below the income tax threshold do not receive any tax relief as their tax rate is 0%. 

 

In a ‘relief at source’ scheme, pension contributions are calculated on net salary, and 20% tax relief is applied for everyone on this; those entitled to higher tax relief can claim the remainder from HMRC. 

 

Giving tax relief to low earners would mean the average beneficiary will receive an extra £53 a year, according to the government. Three-quarters of those set to benefit are women. 

 

Financial Secretary to the Treasury Lucy Frazer said: “A quirk in our pensions tax system has meant that over a million low earners have lost out on government top-ups to their pensions, resulting in comparatively less take-home pay. We are correcting this injustice so low earners will get the same level of government support, no matter what type of pension they use.” 

 

The move to tax relief would also result in a £100 increase in take-home pay for 200,000 people, the government has said, based on the number of people who contribute at least £500 a year to their net pay arrangement but currently get no tax relief on that contribution. 

 

 

One of the firms which had lobbied the government to make the change has been master trust Now Pensions. Its chief executive Patrick Luthi said the change was great news for low earners and will help to address the yawning gender pensions gap. 

   

“Of the 1.2m low earners that HMRC believe will now receive an annual payment, three quarters are women, so this addresses one of the many gender disparities that Now Pensions has been exposing as we push for fair pensions for all,” he said.  

  

Now Pensions has been offering a pension top up since the 2015-16 tax year to low earners who have been missing out through the net pay anomaly. Luthi said this top up will continue for its members for the next two tax years, until the government top up replaces it. 

 

The change was also welcomed by master trust Cushon. “It’s something that we and others in the industry have long campaigned for and is also a major step towards fairer pensions for all, especially women who are most affected,” said Steve Watson, director of policy and research. 

 

 

Although he welcomed the policy change, Watson criticised the government’s pace on fixing the issue and the fact that tax relief will still not be given automatically.  

 

“This change is desperately needed now, not in three years’ time when the legislation comes into force,” he said. “We’re also concerned that there’s a process to follow to get the extra money, which could mean that people still miss out on the money they’re entitled to. It ideally needs to be automatic,” he argued. 

  

Under the new system, low earners will receive a letter from HMRC notifying them of their eligibility. They will then need to provide their bank account details to HMRC to allow it to make the payment. The government has said that “in future years”, HMRC should be able to make the payment without savers needing to supply details. 

 

 

For Watson, the change also highlights just how complex the current pensions tax relief regime is, and pointed to Cushon’s research which shows that half of people do not know how much tax relief they receive. 

 

“The whole system needs to be simplified and made easier to understand so that people can really value the ‘free money' that’s supposed to be an incentive to save,” he said. 

 

Whether pensions tax relief is supposed to act as an incentive was discussed earlier this month at an event by the Chartered Institute of Taxation and the Institute for Fiscal Studies. 

 

    

Speaking at the event, Charlotte Clark, director of regulation at the Association of British Insurers and a former head of pensions at the Treasury and the Department for Work and Pensions, questioned that this was the case. 

 

“I don’t think we can talk about incentives in the pension system. For an incentive to work, people have to understand it,” she said. Pensions tax “does not incentivise saving, it rewards it, and there is a very different mentality between those two things”, Clark stated. “If you believe something incentivises something, then you’re looking at behavioural change. If you believe it rewards it, then it becomes a question of fairness and who do you want to reward.” 

 

Clark, who has occupied key roles in pensions and taxation, suggested the pensions tax system’s sheer complexity prevents the use of incentives, admitting: “I would not put up my hand to say that I understood the pension tax system.” 

 

The Office of Tax Simplification published a review on Monday in which it called on the government to embed simplification in the Treasury and HMRC’s tax policy work. 

 

The OTS proposed that officials should ask four fundamental questions throughout the policymaking process, which should include “ensuring tax policy design is clear and makes sense to people” and fits “with the way life works, the way processes can be implemented or how people think about things generally”.