Tax relief is available for individuals making pension contributions. Employee contributions are generally made under net pay arrangements (NPA) or through relief at source (RAS).
Changes are now being made to align the amount of tax relief available under NPA and RAS for low earners. The government is also amending legislation to allow for digitalisation of the RAS pension tax system. This TAXguide explains how these reliefs operate and the changes on the horizon.
Background
Broadly pension contributions are made in one of two ways.
Employees who contribute to an occupational pension typically do this under an NPA. Broadly 100% of contributions are deducted from gross salary, (ie, before tax has been deducted). Thus, the employee does not pay income tax on an amount equal to their contributions, thereby receiving tax relief at their marginal rate of tax.
Individuals may instead contribute to a scheme that operates RAS. The individual pays 80% of the gross contribution. For employees, the contribution will be deducted from net salary, (ie, after tax has been deducted). The pension scheme receives a top-up of 20% of the gross contribution (ie, 25% of the personal contribution) from HMRC. In the individual’s tax computation, the income tax basic rate band is extended by the gross amount of the pension contribution, providing relief up to their marginal rate of tax.
Top ups for low earners in net pay arrangement schemes
The current position
For most taxpayers the two methods result in the same amount of income tax relief (subject to pension tax relief being restricted for ‘high income individuals’).
However, currently the position differs for individuals whose taxable income is less than the personal allowance. Such individuals either pay 80% of the gross contribution and their pension scheme will receive a 20% top-up if contributing to a RAS scheme, or pay 100% of the gross contribution but do not receive any tax relief when making contributions under an NPA because their earnings are not subject to income tax.
Illustration
Non-taxpayer employee with monthly pay of £1,000 and gross pension contribution of £50.
Net pay arrangement (2023/24)
| £ | |
|---|---|
| Gross pay | 1,000 |
| Pension contribution | (50) |
| Net pay | 960 |
| Income tax | 0 |
| Take-home cash | 950 |
| Total received by pension scheme | 50 |
| £ | |
|---|---|
| Net pay | 1,000 |
| Pension contribution | (40) |
| Take-home cash | 960 |
| Pension contribution | 40 |
| Top up into pension scheme at 20% | 10 |
| Total received by pension scheme | 50 |
The individual contributing through RAS therefore has a higher take-home cash amount, even though the total amount received by their pension scheme is the same.
This difference in outcomes was an issue raised by the Office of Tax Simplification in its 10 October 2019 report, Taxation and Life Events: Simplifying tax for individuals.
Changes to relief on NPA
To equalise the position between pension contributions under NPA and RAS, the government is placing a duty on HMRC to make top-up payments to affected individuals. This will take effect from 6 April 2024, so will affect UK tax years from 2024/25 onwards.
For a given tax year (starting with 2024/25), HMRC will identify individuals who have taxable income below the personal allowance and who have made pension contributions under an NPA. Following the end of the tax year, HMRC will notify those who are eligible to receive a 20% top up and will ask them to provide bank details for the top-up payment to be made to them.
This should align the take-home pay positions between those contributing under NPA and RAS, although there is still a cash-flow timing difference. While details of HMRC’s timeframe for making the top up payments are not yet available, this will be after the end of the tax year in which the pension contribution is made.
More information on the policy can be found in HMRC’s tax information and impact note dated 15 March 2023. The primary legislation is in s25, Finance (No.2) Act 2023, which inserts new s193A, Finance Act 2004.
Pension scheme administration: digitalisation of the administration of RAS pension tax relief top ups
As part of HMRC’s drive for greater digitalisation, the RAS system is being digitalised, with all pension scheme administrators being required to use an online system from April 2025 to modernise the way registered pensions schemes using RAS arrangements claim tax relief on members’ pension contributions.
On 18 July 2023, the government published draft primary legislation for consultation, making amendments that:
- insert failure to comply provisions, enabling HMRC to withdraw registration of non-compliant pension schemes;
- define the relevant rate for Scottish taxpayers, Welsh taxpayers and other UK taxpayers;
- allow HMRC to amend the definition of the relevant rate; and
- allow HMRC to set out in future regulations the consequences of failure to comply with information notices.
Forthcoming secondary legislation is expected to allow for RAS claims to be made and amended on a monthly basis. Under the current system, claims are made on an annual basis via the submission of an annual return of information.
The draft legislation and forthcoming regulations are to take effect from April 2025.
A policy paper and draft legislation contain more information on the proposed changes. Further information about the design of the online system is expected to be available later in the year.
Tax Faculty
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