When will low earners get tax aid on pension funds? Steve Webb

The Government has introduced a new pension top-up scheme for people on low income.

People earning less than the personal allowance of £12,570 do not get tax relief on pension contributions.

The new scheme will pay the tax relief into the bank accounts. Could you please explain how the scheme works? 

SCROLL DOWN TO FIND OUT HOW TO ASK STEVE YOUR PENSION QUESTION 

Steve Webb replies: A letter from HM Revenue & Customs is rarely a cause for celebration, but next year over one million lower paid workers should look out for a letter offering to make a modest payment into their bank account.

The issue affects a particular group of workers who can say ‘yes’ to the following three questions at the end of the current tax year:

– Did you have taxable income less than £12,570 (after allowing for any pension contributions)?

– Did you make personal contributions into a workplace pension?

– Does your pension deliver tax relief through the ‘net pay’ arrangement?

The answer to the third of these should by now be clear to regular readers of my column, but as a quick reminder, there are two ways in which pension savers can benefit from tax relief on their contributions.

The first is known as Relief at Source (RAS) where contributions are made out of your take-home pay, after you have been taxed.

This is the approach adopted for personal pensions and some workplace schemes such as Nest.

In this case, HMRC pay tax relief at the basic rate directly into your pension pot.

Note that these low-paid workers *do* get tax-relief even if their income is under the tax threshold.

The second is the Net Pay Arrangement where contributions are taken from your gross pay, and your income tax bill is worked out on what is left.

In this case the money going into your pension should benefit from tax relief, because your taxable income is lowered as a result of the pension contribution.

This approach is used for most trust-based occupational pension schemes.

In most cases, the outcome for the individual will be broadly similar, regardless of whether the RAS or Net Pay approach is used.

But for many years there has been a concern that one group of workers could lose out if their employer has chosen a scheme which delivers tax relief through the Net Pay route.

This is workers whose pay is under (or just slightly above) the tax threshold.

It is easiest to see this through a numerical example.

Consider the case of a worker on £10,000 per year who has been automatically enrolled into a workplace pension and who wants to put £500 into their pension.

If they are a member of a RAS scheme, they can simply pay in £400 out of their take-home pay and HMRC will then add tax relief of £100, making £500 in total.

But if they are a member of a Net Pay scheme, paying pension contributions will have no impact on their tax bill because their earnings are below the tax threshold.

This means it costs them £500 to put £500 into a pension – £100 more than their counterpart in a RAS scheme.

After much pressure, the Government eventually accepted that it was unfair to penalise these lower earners for a decision over which they had no control, as it is their employers which opt for one scheme or another not them.

So, in July 2022 and after period of consultation, it was announced that the Government would put in place a redress scheme to help these individuals.

The way the scheme will work is that at the end of 2024/25, HMRC will look at membership information from pension schemes which deliver tax relief through the Net Pay Arrangement.

It will identify workers who earn under the tax threshold (or only slightly above) and who made personal contributions into the scheme.

HMRC will then write out to them asking for bank details and will make a payment directly into their bank account (not into their pension).

The size of the payment will simply be the income tax due on the pension contribution.

So, for example, if someone has paid £500 into an occupational pension using the Net Pay Arrangement, HMRC will credit £100 into their bank account.

This means that they will end up with £500 in their pension but at a net cost of £400, the same as someone in a RAS scheme.

In terms of timing, HMRC simply says: ‘Payments will be made as soon as possible after the tax year in which the contribution is paid.’

HMRC estimates that there could be around 1.2million potential beneficiaries, and around three quarters of these are likely to be women.

Once an individual has provided bank details once, they should not need to do so again.

As long as they continue to earn under the tax threshold and to make contributions to a Net Pay scheme, they will continue to receive annual payments.

What is slightly surprising is the relatively low annual cost being assumed by HM Treasury for payments under this scheme – just £10million in 2025/26 and £15million in 2026/27.

The reason the figure is so low is that the Government assumes the scheme will fail to reach a significant proportion of those it is targeting.

In part this is because the low-paid workforce can be particularly transitory and so up-to-date contact details may not be available for some.

Election Money

But a bigger challenge is that some people may simply not respond to the letter (perhaps if the payment is very small) or think it is a scam.

It is therefore very important that, when letters start going out next year, HMRC launches a publicity campaign to reassure recipients of the letters and also to encourage people to come forward who are entitled but may not have received a letter.

Hopefully, HMRC will also help to make sure that people can tell the difference between genuine letters about this and scammers simply trying to get hold of bank details.

HMRC already has a section on its website on how to tell if a communication purporting to be from itself is genuine.