I am returning again to the complicated tax situation that people earning under the nil-rate income threshold find themselves in when saving into pensions.
I’m doing so for three reasons
- From a societal point of view , it is wrong that that some low earners will end up without tax incentives on their contributions and on the income arising from their pension savings while others will get both incentives and tax-free income.
- Where there are trustees involved, there is a clear breach of fiduciary duty in allowing this to happen. I consider this actionable
- Where employers choose to participate in a trust-based pension where this is happening , they are laying themselves open to action from employers in failing to exercise their duty of care.
You may think I am scare-mongering on points two and three , but I am not. If your company runs or participates in an occupational pension scheme that operates on a net-pay basis and if you pay no tax, you are missing out today on a contribution from the Government of 20% of your pension contributions, every time you make one!
Whether the fault lies with the trustees for not making the employer aware of this or with the employer for not ensuring low-earners use a scheme that can give them the incentive, the employee is being deprived of his or her right to the incentive.
The problem at retirement is broader and shallower.
Those who find their earnings (including any pension and taxable benefits from the state) are less than the income tax-threshold, are able to use the gap between what they earn and the income tax threshold to draw income tax free. This is on top of the tax-free cash that they have an entitlement to.
People who draw down so that their total earnings including the drawdown take them into paying basic rate tax, may be paying tax unnecessarily. There will be many more of such people (the issue is broader), but the responsibility for the way they plan their tax is not the employers or trustees (though clearly it would be helpful if they helped those retiring to understand the opportunity to avoid tax). Though the problem is broader- it is shallower.
How can the net-pay problem be avoided?
Many employers will not think they have a problem as they do not currently employ people with low-earnings who will be eligible for a contribution under auto-enrolment. Most employers under-estimate this; even low-earners can spike into auto-enrolment if they have a special pay period where they earn “pro-rata” above the earnings threshold. Unless an employer is quick witted and uses postponement, these people get enrolled and once enrolled there is nothing an employer can do to opt them out.
The best way to avoid the net pay scheme is not to rely on not having no impacted workers but to make sure there is a scheme which they would join which operates on a relief at source basis. All insured contract based GPPS operate on the relief at source basis, so does NEST, so does People’s Pension (unless you choose otherwise) and NOW pensions though it currently operates net-pay currently pays the Government incentive out of its own funds. All other occupational pension schemes operate on a net-pay basis and are to be avoided by low-earners contributing into them.
The second best way to avoid the problem is – where a scheme is net-pay, to make the scheme non-contributory – typically by making salary sacrifice the default mechanism by which individuals increase the employer’s contribution. This is not as clean as it sounds as many low-earners may find that a salary sacrifice takes them below the minimum wage.
What is the risk?
The worst way of dealing with the problem is for employers and trustees to hide their head in the sand and do an ostrich. This is precisely what most large employers operating DC pensions using their own occupational trust are doing and the clock is ticking on the first class action. In my opinion, any law firm that can find a group of employees contributing into an occupational DC plan and not getting either tax-relief under net-pay or the Government incentive under relief at source, is entitled to inform those staff that their employer and the trustees have been negligent and incite a civil prosecution for the recovery of the tax or incentive lost.
An accident waiting to happen
We only have to think of the tragedy of Grenfell to realise that we can collectively suffer a blind-spot with regards the people who we know nothing about.
The problems associated with net-pay are nowhere so grievous as the disaster that befell Grenfell but the underlying issue is the same. Ignore a problem because it is widespread and difficult and that problem does not go away and one day it ignites into a very serious issue.
The plight of those in Grenfell was predicted and we now know there are up to 60 potential Grenfell’s in which people are still living. Urgent attention is being given to the problem now, though it should have been given before the conflagration.
In a much smaller and less acute way, the problem with net-pay needs addressing now, before there is serious civil litigation. With employee contributions rising from 1-3% of salary next April and to 5% the April after that, the scale of the net-pay problem is likely to escalate fast.
What is needed is a top-down bottom-up approach which targets awareness of the issues (and opportunities) of those on low-earnings not to lose but to get really great tax-incentives.
Missing out on the incentive to get tax-back that you’ve never paid (the relief at source opportunity) needs to be promoted to employers and trustees and to employees.
Using the greatly inflated nil-rate band by those who see their earnings diminish or extinguished in retirement, is a second great opportunity.
Put together, these opportunities present a substantial boost to low-earners savings and spending in later life. It is critical that – as with state benefits – we maximise the take-up of these opportunities.
We cannot allow low-earners to be treated as second class retirees.