Tax Boost For Low Earners

In the autumn Budget, the Government announced plans to fix a longstanding pension tax issue: the "low earners anomaly". This is a positive development for low-earning members under "net pay" schemes. For employers it signals that other, less attractive, proposals are no longer on the table.

The anomaly

Members of DC schemes receive tax relief in one or other of two ways: "net pay" and "relief at source".

Most occupational pension schemes, including many master trusts, work on the net pay basis. Members' contributions come out of their pre-tax earnings. They pay tax only on the earnings which remain.

Relief at source ("RAS") is generally associated with personal pension schemes, though some master trusts offer it as an option. Under an RAS scheme, members' contributions come out of their taxed earnings. But the Government makes top-up contributions which effectively deliver tax relief at 20%. Higher-rate taxpayers can claim additional relief via their tax returns.

There are pros and cons to each system. For most members, net pay is felt to be the more attractive, as it delivers tax relief up-front via a straightforward mechanism.

But for low-earners, there is a significant anomaly. Members who pay no tax (or whose marginal tax rate is less than 20%) fare better under RAS than under net pay. For example, take a member whose earnings are below the personal allowance for income tax (£12,570), and who pays annual contributions of £600. Under a net pay scheme the member sees no tax benefit. But under RAS the Government would pay a top-up contribution of £150.

Proposed solution

The Government had pledged to address the low earners anomaly, and in 2020 launched a consultation about possible ways of doing so.

In his October 2021 Budget, the Chancellor announced that a decision had been reached. From 2024/25 onwards, low earners in net pay schemes will be able to claim top-up payments after the end of the relevant tax year. Such payments will be made directly to individuals, so the administrative burden for in-scope schemes will be minimal.

There will of course be a burden for low earners - they will need to submit a claim in order to receive a top-up payment after the event, rather than (as under an RAS scheme) receiving a top-up contribution automatically and up-front. However, for employers with part-time or occasional workers pensioned under net pay schemes, the Budget announcement feels like good news. And employers will surely welcome the Government's decision not to proceed with alternative fixes which it was considering - for example, doing away with top-up payments altogether, or requiring employers to offer workers both a net pay scheme and an RAS scheme side-by-side.

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