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Are your employees making the most from pension tax relief?

Are your employees making the most from pension tax relief?
Paul Chappell
Written by Paul Chappell
Thursday, 01 August 2019 13:31

Tax and Pensions. These two words can strike fear into the heart of many. So when the two come together it’s not for the faint hearted. This time, however, we come bearing good news: most employees can claim at least 20% tax relief on their pension contributions.

There are three different ways that tax relief is available and at Dataplan we are able to process all three. We recommend checking with your pension provider as some may only operate in one way.

So what are the options?

1. Relief at Source

With this method, it is the responsibility of the pension provider to claim the tax relief. 

The employer takes 80% of the employees’ pension contributions from net pay at each pay period, so this is after income tax has been deducted.

The pension company will then claim the tax relief from HMRC, however, whether the employee is a higher rate tax payer or not, the claim by the pension company is only at the basic rate of 20%. Higher rate taxpayers will need to complete a self-assessment tax return to claim the additional tax relief. 

After the April 2019 increase to minimum contributions, under the auto-enrolment provisions, most pension contributions have increased to 3%, employees contributions have increased to 5% of their pensionable pay. Under this arrangement the employee would have 4% of their net pay deducted through payroll and the pension provider can claim tax relief on the additional 1% from HMRC, to meet the minimum.    

2. Net Pay arrangement

Unlike the relief at source method, the tax relief is applied entirely through payroll. 

Let’s assume again the employee is paying 5%. The 5% pension contribution is calculated from their gross pay but the gross pay for tax is reduced by the pension deduction meaning tax is not paid on that amount.

This method is preferable for higher rate taxpayers as full tax relief is automatically received, at 40% or 45%, as no income tax is paid on the pension contributions. As full relief is obtained at this point, the pension scheme provider will not recover any tax relief form HMRC.

 

The downside to a net pay arrangement is that employees who do not pay income tax, do not receive tax relief on their contributions from the Government.   

3. Salary Sacrifice

Under a Salary Sacrifice arrangement the employer pays the full amount of the employee’s pension contributions in exchange for the employee sacrificing some of their salary. 

Unlike the previous two methods, there are additional savings to be made for both the employee and employer (however see later) and additional sums are paid into the pension scheme at no extra cost. This is due to fact that the amount of the pension contribution is sacrifices from salary, this is done before tax and NIC is calculated. A contribution of £100 goes to the pension scheme in its entirety. 

The pension scheme does not need to reclaim tax relief from HMRC because not tax has been paid on the sacrificed salary. In addition there is the employees NIC saving of 12%. So on the £100 contribution, the employee (at basic rate) is saving 20% tax and 12% NIC. That leaves us with the employers NIC saving of 13.8%. The employer is free to do with this saving whatever they wish. 

There is a potential staff welfare benefit here as the employer is free to make the full employers NIC saving as an employer contribution into the pension scheme. If the full employer NIC saving is paid into the employees’ pension scheme the contribution becomes £113.80. A significant uplift for the employee! 

A word of caution though, such an arrangement does require a change to the employees contract of employment.  

I will be looking into the advantages and disadvantages of these methods, particularly salary sacrifice, in further blogs so stay tuned.

Paul Chappell

Paul joined Dataplan from HM Revenue and Customs in 2007 and runs our PAYE compliance and investigation services.

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