Net Pay or Relief at Source? Why Pension Tax Relief Errors Are Under the Spotlight
A recent press release from the Low Incomes Tax Reform Group (LITRG) has highlighted
an issue that arises more often than many employers realise: applying the wrong type
of pension tax relief to a workplace pension scheme.
It may sound like a technical detail, but getting it wrong can mean employees miss
out on pension tax relief they are entitled to, sometimes for years without anyone
noticing.
Why It’s Back in the News
LITRG is calling on HMRC to investigate how widespread these errors are before the
introduction of a new pension top-up payment scheme for lower earners.
The concern is that if HMRC’s records do not accurately show whether employees are
enrolled in a Net Pay Arrangement or a
Relief at Source pension scheme, the new top-up payments could be
sent to the wrong people or fail to reach those who are genuinely entitled to them.
The Two Systems Explained
Both pension tax relief methods are designed to ensure employees receive tax relief
on their pension contributions in line with the Income Tax they pay.
The difference lies in how the tax relief is applied.
Net Pay Arrangement
- Pension contributions are deducted from an employee’s gross pay before Income Tax is calculated.
- Tax relief is applied automatically through payroll.
- This approach only benefits employees who actually pay Income Tax.
- Employees earning below the Personal Allowance receive no tax relief because there is no tax to offset.
Relief at Source
- Pension contributions are deducted from an employee’s net (after-tax) pay.
- The pension provider claims basic rate tax relief directly from HMRC and adds it to the employee’s pension pot.
- This means employees earning below the Personal Allowance still receive basic rate tax relief, even if they pay no Income Tax.
Because these two methods treat lower earners very differently, applying the wrong
system can have a significant financial impact on employees who are least able to
absorb the loss.
Where the Confusion Comes From
According to LITRG, part of the problem is simply the terminology.
The names Net Pay Arrangement and
Relief at Source are not particularly self-explanatory, making it
easy for payroll teams, especially those managing multiple pension providers or
schemes, to lose track of which arrangement applies.
There is also concern that HMRC’s own records may not always accurately reflect
which tax relief method is being used for individual employees, increasing the risk
that errors remain unnoticed.
What This Means for Employers
This is more than just a technical payroll issue.
If your workplace pension operates under a
Net Pay Arrangement and you employ a significant number of
part-time or lower-paid staff, some employees may be receiving no pension tax relief
at all. While this may be technically correct under the rules, it is something many
employers and employees are unaware of.
What We’d Recommend Doing Now
- Check which tax relief method your workplace pension scheme uses and confirm it
matches the configuration within your payroll software. - If you employ a significant number of staff earning below the Personal
Allowance, consider whether a Relief at Source pension scheme
would provide a better outcome for those employees. - Ensure the people responsible for payroll and pension administration fully
understand the difference between the two methods to avoid costly mistakes. - Keep an eye on the forthcoming low-earner pension top-up scheme. If your pension
arrangement is not accurately reflected in HMRC’s records, eligible employees
may not receive payments they are entitled to until those records are corrected.
Where Pecunia Pro Fits In
Pension scheme administration is one of those areas where a small configuration
decision can have a significant impact, particularly for lower-paid employees.
As part of our payroll and pensions service, we check that the tax relief method
applied to your pension scheme matches the way it has actually been configured and
highlight any discrepancies that could be costing your employees money.
Speak to Pecunia Pro
Want a second opinion on whether your workplace pension scheme is set up correctly
for pension tax relief?
Call us on
020 8143 1529
or email
info@pecuniapro.co.uk,
and we’ll be happy to review your pension setup with you.