A friend, a Director of NOW Pensions and a man whose integrity cannot be questions , has sent me this paper. I had thought to take thoughts on it privately, but in the light of the controversy over “net pay” this week, I’ve decided to publish it anonymous to its author.
I am sure that the problem with net pay was unforeseen by NOW and other net pay pensions. While NOW had an opportunity to remedy the situation when they switched administrators late in 2014- and while that opportunity was missed – NOW is taking steps to solve the problem (partly caused by HMRC). That HMRC are part of the solution, seems only fair.
But this is not just NOW’s problem, it is a problem for the vast majority of occupational pension schemes and I would be interested to hear from the PLSA on this as (to date) they have been silent.
A lot of contributions will “flow under the bridge” before the pension taxation reforms are implemented and my personal view is that this solution strikes a balance between an expensive full solution and the current inactivity that seems the default position for occupational scheme trustees (and their trade body).
At the end of this blog, I call on readers to vote on whether this solution is workable. I will share the results of this poll to NOW pensions and with the Pension Minister.
Sent to me by email
End of year sweep up to resolve “net pay” lost tax relief
The Issue
Employees in a pension scheme operating under the net pay system get their pensions tax relief automatically as their employee pension contribution is deducted from their gross pay before the remaining taxable earnings are fed into the PAYE process in payroll.
This breaks down where an employee earns less than the income tax personal allowance, currently £10,600pa. They pay no tax but they get no tax relief.
In contrast, the equivalent employee within a PTRAS (pensions tax relief at source) scheme is given a 25% uplift to their employee pension contribution through the PTRAS payment that the pension provider claims on their behalf. This 25% uplift is equivalent to 20% tax relief and is given to all taxpayers, even if they have no earnings or are a higher rate taxpayer.
Available data
Pension schemes keep records of the amount of employee contributions made to the pension scheme
HMRC have records of taxable earnings at the end of the tax year from the employers P60 forms completed for each employee through payroll at the year end.
Sweep up solution
This solution starts by looking at an employee who has one job and one pension scheme through the whole tax year. We look at alternative more complicated employment scenarios later.
At the end of the tax year, the pension scheme submits a declaration to HMRC of employee contributions received under the net pay method, showing one line per member, identified by national insurance number and showing their total employee pension contribution during the year.
HMRC match the pension data against P60 data, and identify employees who missed out on pension tax relief because they paid pension contributions under a net pay arrangement but received no benefit as their total taxable earnings for the year was below the income tax personal allowance.
HMRC calculate the missing relief, which will be 25% of the pension contribution, but subject to a ceiling as if the total of taxable earnings for the year and pension contributions made is greater than £10,600 then relief will have already have been granted under net pay for the top slice of pension contribution that took the total above the personal allowance.
HMRC send one payment to the pension scheme with a record breaking it down to the amount for each employee against their national insurance number.
The pension scheme applies the payments to the accounts of each affected individual, purchasing additional units at the date of receipt of the payment from HMRC. The payment is shown on the employee’s pension plan as “tax relief for employee earning below Income Tax Personal Allowance”
Conclusion
The current issue, which is attracting adverse commentary in the media and concern from the Pensions Minister, is resolved.
- There is some additional work for both pension providers and HMRC, but it is only on a once a year basis and is suitable for automation and bulk claims.
- There is no additional burden on employers from this solution.
- No action is required from employees, supporting the “inertia” philosophy behind automatic enrolment.
Further work is required to analyse more complicated employment patterns and the first “alternative employment scenario” is set out below. As we work through these it is likely that some additional requirements may be added to the process above so that the reclaim remains robust for more complicated employment patterns. This is particularly important for the demographic affected by this issue – people earning below £10,600 pa are obviously not full time 9 to 5 employees and will often exhibit unusual employment patterns driven by their personal situation.
Alternative scenario 1
Employee moves from employer A to employer B during the tax year, both employers use net pay schemes and the employee is auto-enrolled into scheme B before the end of the year
What happens
Employer A completes a P45 on leaving service, employer B enters the P45 details into their payroll system, tax is paid under PAYE for employer B and at the end of the tax year employer B issues a P60 to HMRC
Both Scheme A and Scheme B will submit their employees’ pension contribution data to HMRC at the end of the tax year.
HMRC collates the “taxable pay” data from both employers and the employee contribution data from both pension schemes, and then calculates any additional tax relief due as before
What needs to be added to the basic procedure :
As the HMRC calculation cannot be done until both Scheme A and Scheme B have submitted their declaration, there needs to be a deadline, requiring pension schemes to submit their declarations ahead of a set date, which might be 1st July following the end of the tax year.
HMRC will need to know which scheme to send the payment to. This suggests two further entries for the scheme data sent to HMRC
“do you still hold pension assets for this member?”
“date of most recent contribution received”
That would enable HMRC to send the tax relief to the scheme which has most recently received contributions and which still holds assets for the member
Further reading!
If you want to learn more about the background to this issue, you might want to read my blog on why things must change (which you can find here). The position of the Pension Minister on net pay can be accessed here, and here is the original story I wrote on the matter.
Now that payrolls now use RTI to HMRC, surely the process of returning tax relief does not have to wait until the end of the tax year?
Great point Gerry – food for thought!
being targeted.
I started off by referring to tax free allowance and not personal allowance. That is because an individual’s tax free allowance is determined by HMRC through their tax code. The individual’s tax free allowance can be higher or lower than their personal allowance, that is HMRC are collecting under deducted tax from previous years, or the individual has an entitlement to additional personal allowances, blind person’s allowance, professional subscription fees, transfer of personal allowance from non working spouse or partner etc., or may have more than one source of income. This is going to make end of year reconciliation that much more complicated.
The annual reconciliation process, being described sounds to me very much akin to the monthly relief at source reconciliation between schemes and HMRC. Here the scheme receives £8 which has been deducted from pay from the employee and claims the missing £2 direct from HMRC. This reconciliation process takes 6 – 8 weeks to complete.
The issue then becomes when will tax relief from HMRC invested. Many larger providers pre fund the investment of HMRC tax relief. To do otherwise is not in line with employees’ expectations who expect to see £10 invested soon after it has left their pay packet.
Apologies, comment should have read
Henry,
Am I missing something? For a basic rate tax payer, once their tax free allowance is exceeded, the payroll will deduct 20% of earnings to pay as tax to HMRC before other deductions are made. The employee receives the net amount after tax and other deductions.
Under Net Pay, if a basic rate employee is making a £10 pension contribution the payroll will pass £10 to the scheme but exclude that £10 from the taxable income on which tax is paid. The result is that the gross contribution is paid to the scheme before tax is deducted and employee pays £2 less income tax. That is, £2 is in the employees pocket, not the in the scheme.
The problem is for a non tax payer the £10 is paid to the scheme but the cost to the employee is also £10 because as there is no reduction in tax paid that ends up in the employee’s pocket.
If I follow the suggested solution correctly, at year end the scheme would receive £2.50 in addition to the £10 it has already received. This is not the result that is being targeted.
I started off by referring to tax free allowance and not personal allowance. That is because an individual’s tax free allowance is determined by HMRC through their tax code. The individual’s tax free allowance can be higher or lower than their personal allowance, that is HMRC are collecting under deducted tax from previous years, or the individual has an entitlement to additional personal allowances, blind person’s allowance, professional subscription fees, transfer of personal allowance from non working spouse or partner etc., or may have more than one source of income. This is going to make end of year reconciliation that much more complicated.
The annual reconciliation process, being described sounds to me very much akin to the monthly relief at source reconciliation between schemes and HMRC. Here the scheme receives £8 which has been deducted from pay from the employee and claims the missing £2 direct from HMRC. This reconciliation process takes 6 – 8 weeks to complete.
The issue then becomes when will tax relief from HMRC invested. Many larger providers pre fund the investment of HMRC tax relief. To do otherwise is not in line with employees’ expectations who expect to see £10 invested soon after it has left their pay packet.
I think clue is in the terminology: tax RELIEF is intended to reduce the tax which someone has paid or would otherwise have paid. So under Net Pay, a non-taxpayer does not get tax relief because he hasn’t got any tax to relieve.
Under Relief at Source, by contrast, contributions are grossed up regardless of tax status – this is not so much tax relief as a tax INCENTIVE. Whether it was intended as an incentive when introduced back in the 1980s is open to question.
Do we really think that George Osborne is now going to extend that tax incentive to millions of people who contribute to pensions under Net Pay? In current circumstances I think it highly improbable! Much more likely that he will level down rather than level up in my view.
Highly impossible? Are their differing degrees of impossibility Ted? I’d like to think that George will look kindly on the low wages- as he always does
Ted,
Net pay has always caused problems with DC pension provision. I have come across senior employees who at the end of a good earnings year will pay a large contribution at the end of the tax year only to find that because the contribution is greater than their March salary they do not get full tax relief. Also, any solution has also to work for defined benefit schemes where members also receive tax relief on their pension scheme contributions through Net Pay.
Neither system is perfect, under Net Pay non taxpayers do not get tax relief, under Relief At Source higher rate tax payers have to wait for their tax relief. However on the latter point HMRC are often willing to adjust tax codings to take account of regular pension contributions.
Therefore in my view Relief at Source is the direction all DC pension schemes should be going down.
Moving from Net Pay to Relief at Source should not be a big problem for scheme providers / administrators. It may however cause problems getting employers to change and issuing clear communications to employees on what is changing. However many employers have already completed this task when moving from an Occupational Scheme to a Group Personal Pension Scheme.
Too many steps Henry and more compliance re the returns needed
Also we don’t know if HMRC and/or HM Treasury are counting on this under claim?
I have a simpler solution and will finish it for publication soon
Best
Robert Reid