Why are so many low-earners over-paying their pensions?

This article forms part of AgeWage’s response to the Government’s call for evidence on the administration of pensions tax-relief . Here we look into the historic reasons for the preponderance of net- pay arrangements – especially where large employers are sponsoring DC pensions.

AgeWage is a company set up to help consumers better understand the pension policies they have established. It regards the consumers of pensions in this context as any person or organization who makes use of the generous incentives offered by the Treasury to improve retirement incomes. “Consumers” therefore include employers setting up workplace pensions under auto-enrolment and previously under voluntary arrangements- whether these be employer based contract schemes or trust based arrangements.

The Treasury’s call for evidence on Pension Tax relief  looks to understand what are the factors that influence a pension scheme in its choice between using net pay or RAS for its members. AgeWage has looked into this, taken views from the market and has these comments to add to the consultation.

There are three historic influences why net pay arrangements have been used historically , even to the detriment of low earners.

  1. The needs of the sponsor
  2. The needs of the members
  3. The capacity of the provider

Needs of the sponsor

Employers seek to target contributions towards most valued staff. Scheme design has historically included features that excluded short service staff and discriminated against lower earners on a range of grounds including executive contribution tiers, entry age criteria and most commonly vesting periods. Pension schemes did not reward equally but were clearly biased towards higher-earning employees with long service.

In this context, the idea of incentivizing short-term and low-earning staff has never been a priority. While the cost to the employer of providing the low paid with incentives under RAS is zero, the practice means that higher rate tax-payers need to claim back higher rate tax relief to their inconvenience.

There is no fiscal incentive for those with strategic control of pension arrangements to choose RAS over a net-pay system and calls to do so have met with the statement “tax-relief is for those who pay tax”. This despite many higher earners setting up stakeholder pensions for children who did not pay tax (but were incentivized under RAS as if they did).

The messaging (as per the illustration below from 2014) shows how little awareness there was that pension contributions might not attract relief. The illustration comes from Government to show how workplace pensions work.

Needs of the member

There is no doubt that the net pay system works better for those who pay tax and particularly for those who pay tax at higher marginal rates. They get the benefit of tax-relief through a pay-coding adjustment and this makes it easier and quicker for the tax savings to benefit them. We know that many higher rate tax payers forget or don’t know to claim back the higher rate tax due to them under RAS.

For high earning workforces with no staff earning below the LEL, net pay is clearly the right choice for members. The revers is equally true.

However, while high earners have a say, low owners generally don’t and therefore many schemes are set up ignoring the needs of many members.

Needs of providers

The idea of using relief at source to provide workplace pensions is relatively new. DC occupational pensions are generally used for future accrual of pension benefits that were provided as defined benefits. All DB schemes operate under net pay and the provision of occupational DC schemes, was typically made using the same administrators as offered the DB administration. Here the choice of contribution method was influenced by continuity and a reluctance of administrators to operate a new system in conjunction with the old. Many master trusts such as NOW and Smart simply inherited old style administration , because that was all that seemed on offer.

Many advertisements  (such as the one above) suggested that employers and staff had no need to take decisions and could simply leave all choices to the provider

The decision of Nest , to adopt relief at source and of People’s Pension to offer a choice are today seen as “enlightened”. But for most of the staging period they were the only trust based schemes operating RAS with capacity for large employers

Even today , there is very little more choice for employers who want to use occupational schemes and ensure low-earners are not over-paying their contributions. However, since demand from sponsors remains weak and awareness from impacted members non-existent, it is not surprising that most commercial master trusts and the administrators of single employer trusts , have done little about this problem.

It needs to be pointed out that historically , the numbers of employees excluded from incentives under net pay was much smaller than today. Many part-timers and contractors who are eligible for an employer contribution were not eligible for workplace schemes which could create their own eligibility conditions. The chart below shows the spike in new entrants from a large sized employer scheme in 2013 when the employer staged auto-enrolment

It can be seen how from 2013 new entrants (marked by the yellow numbers) spiked and then continued at around ten times the numbers prior to auto-enrolment (staged in 2013).

In this case (and most others), the earning demographics of the scheme changed from being based on high earners to a much more general basis. This employer retained the same basis of contribution and no review was made of the scheme when the surge occurred.

Our conversations with consultants to schemes such as the one illustrated suggested that the primary driver for the choice of the AE workplace pension was continuity with the past not suitability going forward and this was for good reason. For most employers staging auto-enrolment , the biggest risks were seen as non-compliance with AE contribution regulations. The introduction of a new provider or a new means of administrating tax-relief would have been a means to increase not mitigate this risk.

It should also be noted that for schemes of the size of the anonymous employer above, the net pay anomaly in 2013 was hardly an issue as the lower earnings limit and the AE contribution threshold were much more aligned, there were fewer affected and the affect on those caught, much smaller.

We have spoken to a large number of employers and their advisers and understand that when schemes were selected or reviewed, the impact of excluding low-earners from Government incentives available under RAS were simply not discussed.

The decision of many early staging auto-enrolment employers do adopt net pay schemes for low-earners was made for a large number of reasons including the perceived better governance of a trust based arrangement, perceived better investment options for members, perceived better targeted communication to members and a long-standing distrust of insurance company administration.

Evidence from consultants

If the Government is looking to better understand the market dynamics of large scheme decision making, it would be best to focus on the consultants who worked with employers and their trustees.

These consultants typically administered the very largest schemes under “unbundled arrangements”, where administration was awarded as a separate mandate under what were called “third party” arrangements. Third party administrators were exclusively working using net pay and it is only very rarely that large employers have moved away from a pure net pay tax-relief administration. Tescos are an example of such an employer – splitting staff between net pay and RAS, few employers have followed.

While consultants today  take pains to advise employers about this issue, this is relatively new. Having worked in consultancy from 2005- 2019, I (Henry Tapper) only started campaigning for greater awareness of this issue from 2015.

Requests for information to providers in the early years of the century rarely so much as asked the basis of tax relief administration available from providers so in summary the decision by most large employers to adopt net pay arrangements was made without thought to the tax consequences of low earners. Many low earners can therefore consider they are losing out for no good reason and – when they get to know their workplace pension – may well feel aggrieved because of this.


About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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