During the UK’s Spring Budget in March, the Chancellor stuck to a promise in the Conservative Party manifesto to review a problem with pensions tax relief, which leaves some lower earners missing out on a 20% addition to their pensions savings.

In theory, non-tax paying pension scheme members should receive basic rate tax relief on net pension contributions of up to £2,880 per year, resulting in a total contribution of up to £3,600. In practice the relief is only open to employees whose pension contributions are paid on a relief at source basis – and not to the majority of employees who receive their salary through net pay arrangements.

Payment arrangements have no impact on pensions tax relief for basic or higher rate taxpayers as they either get tax relief on their contributions through a top-up from HMRC or by claiming it on their tax return.

Whether or not non-taxpayers get the tax relief boost on their contributions depends entirely on the type of scheme their employers run, says Peter Bickley, Technical Manager in ICAEW’s Tax Faculty. “Many low-paid employees in the public sector are paid through net pay arrangements so they don’t get the boost, which is unfair.”

Fixing the problem

In a call for evidence on this issue published during the summer, HM Treasury set out four potential approaches to solving this problem. If the government does go ahead and makes any changes, then out of the proposals in the paper ICAEW recommends taking the first approach: paying a bonus using RTI data.

This approach would require IT changes and there would need to be additional administrative input from employers, members, HMRC and possibly the pension schemes, says Bickley. “We think this could help to incentivise pension saving and, out of the four approaches, this approach or a variation of it would be most worthy of further consideration.”

He sees problems with all the other approaches. The second, a standalone charge, would take relief away from non-taxpayers while still giving it to higher taxpayers. The third approach requires employers to run schemes in a way they are not currently running them – a big ask for employers.

Meanwhile, the fourth option would require every direct contribution scheme to change its rules. “If this approach were adopted then we think direct benefit schemes should be treated the same. Since most of those that are left are public sector schemes, that may require changes to legislation, which would add to the complication,” says Bickley.

The bigger picture

While ICAEW appreciates the problem with current pensions tax relief for some non-taxpayers, its view is that this is not the right time for piecemeal change.

The many changes to the pension system in the last decade have increased complexity but the current rules are widely understood, says Bickley. “There is a danger that the potential complications of further changes could outweigh any benefit – especially at the current time, when businesses have many other pressing priorities.”

Before the Spring Budget there was talk of reducing pensions tax relief for higher rate taxpayers, something that the government has now put on hold. Might both issues be included in a larger review of tax relief on pension savings – a review with a broader remit?

It could be, says Bickley. “It would be better to tackle everything in one go rather than staggering different sets of disruptions. This might just be one aspect of something larger that the government is considering.”