A quirk of the pension tax relief system could leave millions of low earners with a smaller pension pot.
One of the benefits of saving into a pension is that you receive a certain amount of tax relief on the contribution you make.
This tax relief is based on a person’s rate of income tax, with basic rate taxpayers enjoying 20 per cent relief, higher rate taxpayers getting 40 per cent and additional rate taxpayers benefitting from 45 per cent.
However, there are two different ways that employers can deduct contributions. The first type is called ‘relief at source’ and sees contributions taken from a person’s net salary before the tax has been paid.
Under this method, an employer takes 80 per cent of the total contribution from a salary, with the pension scheme then claiming 20 per cent directly from the Government.
This offers a boost to those who earn less than the personal allowance (£12.570), as it means that they don’t pay any income tax, as they still receive the tax relief.
The other method employed is referred to as ‘a net pay arrangement’. This sees contributions deducted from gross salary before tax has been taken.
The premise behind this approach is that contributions will lower the amount of income tax paid on the remaining salary. This makes no difference to those who are not earning enough to pay income tax.
The Government consulted on this issue last year after estimates suggested that this quirk in the different methods had cost low earners almost £150 million.
Despite launching a review into this anomaly, it has not yet published plans to resolve these issues, which means the pension contributions of low earners change based on the sort of scheme their employer uses – unfairly penalising some employees.