Tax Relief on Pensions
Tax relief on pensions should be straightforward, but can become complex, and sometimes people get lost with what is supposed to be happening with their pension contributions. As more employers become involved with auto-enrolment pensions, we are commonly receiving questions about tax relief.
Some pension providers only have one default scheme type, so they may only offer relief at source or a net pay arrangement; it is important to be aware of what the implications are
There are two ways of receiving tax relief, and also salary sacrifice / exchange schemes. Salary Sacrifice is slightly different, managed separately for auto-enrolment pensions, and will be dealt with later
1. Tax Relief at Source
With this type of contribution the deduction is made after all tax and NI has been calculated, and so from the employee’s net pay. The pension company will then add tax relief at 20% back into the member’s pension pot.
Higher rate tax payers may need to claim money back via their Self-Assessment tax return. They will only have received tax relief at 20% on their contributions, rather than 40%.
If an employee does not earn enough to pay Income Tax, they can still receive tax relief on pension contributions. The tax relief is currently available on contributions up to a maximum of £3600 per year or 100% of earnings, whichever is greater.
Relief at Source is usually considered fairer for lower paid workers.
2. Under a Net Pay Arrangement
With this type of contribution the deduction is made after NI but before tax has been calculated, and is sometimes called “Gross for Tax”. There is no tax deducted from the pension contribution.
Higher rate tax payers do not need to do anything, as they have not paid tax on their contributions, and so have already received full tax relief.
Lower paid workers may be disadvantaged however, as they will not receive tax relief if the contributions mean their earnings are below their personal tax threshold. This is why relief at source schemes are usually recommended for lower paid workers.
Pensions and Payroll
The way the scheme is treated for tax will affect how the contributions are calculated, and the information submitted to HMRC with the payroll. It is very important the scheme is set up correctly within the payroll, as errors are difficult to resolve at a later date.
Examples
Example 1: £1000 earnings and 1% employee, 1% employer pension scheme
| Employer Contribution | Employee Contribution | Approximate Net Pay after Pension Deduction | Tax Relief Claimed by the Pension Company | Total Contribution to the Pension | |
| Tax Relief at Source | £10 | £8 | £935 | £2 | £20 |
| Net Pay Arrangement | £10 | £10 | £935 | £20 |
Example 2: £800 earnings and 1% employee, 1% employer pension scheme
| Employer Contribution | Employee Contribution | Approximate Net Pay after Pension Deduction | Tax Relief Claimed by the Pension Company | Total Contribution to the Pension | |
| Tax Relief at Source | £8 | £6.40 | £778 | £1.60 | £16 |
| Net Pay Arrangement | £8 | £8 | £777 | £16 |
A typical UK worker on a monthly salary with a 1100L tax code and NI category A
Example 1: £1000 earnings and 1% employee, 1% employer pension scheme
Employer ContributionEmployee ContributionApproximate Net Pay after Pension DeductionTax Relief Claimed by the Pension CompanyTotal Contribution to the PensionTax Relief at Source£10£8£935£2£20Net Pay Arrangement£10£10£935£20
Example 2: £800 earnings and 1% employee, 1% employer pension scheme
Employer ContributionEmployee ContributionApproximate Net Pay after Pension DeductionTax Relief Claimed by the Pension CompanyTotal Contribution to the PensionTax Relief at Source£8£6.40£778£1.60£16Net Pay Arrangement£8£8£777£16
It can be seen that in example 2 although the pension contributions are the same the take home pay will be slightly less under a net pay arrangement.
Helpful Tips
If the amounts are the same for employees and employers on the payslip it will generally be a gross for tax deduction under a net pay arrangement. If the employee is contributing 80% of the employer’s amount, it will usually be a deduction with tax relief at source. This should be confirmed with the pension company.