Hundreds of thousands of low-paid workers are being denied up to £720 of free Government pension cash a year due to a tax technicality critics are calling ‘indefensible’ and an ‘utter scandal’.
Workers auto-enrolled into pensions are told the money they pay into their retirement pots will be topped up with both employer and Government cash.
But for many on a low pay-rung this is not the case. They never get the Government tax relief, because their employers – often unwittingly – sign up to one of the many ‘master trust’ pension schemes that don’t pay it into their pots due to a little-known tax quirk.
Tax technicality: Hundreds of thousands of low-paid workers are being denied up to £720 of free Government pension cash
Many thousands more workers will have been caught out as pension auto enrolment has prompted more than nine million more people to save for retirement.
The plight of low-paid workers, who often lose a chunk of their pension top-ups without realising, is being flagged by former Pensions Minster Ros Altmann. But she claims her pleas to fix the system have gone ignored.
‘This is an utter scandal and pension providers, Government and the Pensions Regulator are disgracefully forcing the lowest earners – mostly women – to pay an extra 25 per cent for their auto-enrolment pension and what’s even worse nobody is telling them or seems to care about the injustice.
‘The low earners need every penny they can get and taking money from them without proper risk warnings is so wrong.’
Why are some lower earners losing pension top-ups?
How does auto enrolment work?
Workers aged between 22 and state pension age and earning at least £10,000 a year from one job are now automatically signed up for a pension, unless they make an active move to opt out.
The slice of annual earnings used to determine the amount of contributions that ends up in someone’s work pension fund is currently between £6,032 and £46,350.
This is the minimum, but some employers choose to be more generous.
Most master trusts, which manage centralised funds for lots of employers at once, use a tax mechanism called ‘net pay’ that is convenient for top-paid staff but penalises lower earners.
This allows higher rate taxpayers on £46,350-plus a year and additional rate taxpayers on £150,000-plus a year to avoid filling in annual tax returns to get Government pension top-ups, in the form of tax relief on their contributions. They get them automatically.
But it means anyone in the workforce earning between £10,000 and £11,850 a year loses their top-ups for good, with no option available at present to claim them back.
The technical snag arises for this cohort of workers because they start qualifying for employer and Government pension top-ups under auto enrolment when they earn £10,000 or more, but they don’t start paying income tax until they earn £11,850 a year.
Those low earners who manage to throw the maximum possible £2,880 a year into their pots under auto enrolment stand to lose £720 annually.
There is an alternative tax mechanism which master trusts can use called ‘relief at source’ that does not disadvantage people on low wages.
It gives the low-paid workers their Government pension top-ups, which they would otherwise be denied, while better paid workers still end up getting their full whack by submitting a tax return. Basic rate taxpayers are not affected either way.
Net pay and relief at source
Employers and their pension providers have two options when handling pension tax relief for staff.
Net pay means workers contribute directly into their pension before their tax bill is calculated, so their pension tax relief is already included and there is no need to claim it from HMRC.
Under relief at source the pension provider claims the income tax relief directly from HMRC and adds it to each worker’s pension.
This is Money’s pension columnist Steve Webb explains in more detail here.
The Pensions Regulator explains the difference between the two systems here.
It tells employers: ‘Some schemes that use net pay arrangement may have lower member charges for your staff so you will need to consider this carefully.
‘If you use salary sacrifice to manage pension contributions, staff who don’t pay income tax won’t get tax relief whichever tax relief method your scheme uses.’
Master trust providers benefit from a ‘net pay’ system because they get the higher rate tax relief into their scheme, which generates more fees and gives them a larger fund to manage. Under ‘relief at source’ only basic rate tax relief goes into it.
A new investigation by pension consultant Hymans Robertson found 14 out of the 17 top players use the ‘net pay’ system. However, one of these, NOW:Pensions, reimburses low-paid members their lost top-ups, so they do not end up out of pocket.
The three master trusts offering ‘relief at source’ arrangements are state-backed auto-enrolment scheme NEST, Legal & General, and The People’s Pension. See the results below.
Net pay vs relief at source: The 14 firms offering net pay were asked for comment and their responses can be found below (Source: Hymans Robertson)
This issue affects low-paid staff in work pension schemes run by single employers as well, not just master trusts which operate a fund for many employers at once.
The former tend to use ‘net pay’ too, although some will put such staff into one of the auto enrolment schemes, like the state-backed NEST or The People’s Pension, that do offer ‘relief at source’.
What are master trusts?
The Government drive to auto-enrol all workers into pensions led to the rise of dozens of master trusts, which manage centralised funds for several employers at once.
It has passed legislation to protect savers using master trusts from losing their nest eggs.
Will this be fixed so low earners get pension top-ups?
‘I’ve written about this since I discovered it, have begged the regulator to sort it out, one pension provider has agreed to pay the low earners their tax relief but the vast majority just keep taking low earners’ money,’ says pensions campaigner Ros Altmann.
‘The last thing we need is another pension scandal but, sadly, that is what this is.
‘There is no mechanism to allow low earners to reclaim the tax relief they should receive and would have had in a relief at source scheme.
‘I have asked the Treasury to allow this, but they say it is not possible. So unless the pension provider pays their tax relief for them, or their employer does, they simply lose the money.
Lady Altmann went on: ‘Anyone who pays higher rate tax will have to reclaim their higher rate relief if their employer uses a relief at source scheme. That may be a little inconvenient for them, but of course they can get the money unlike the low earners who have no way of reclaiming anything and just don’t get what they should have.
What does the Government say?
‘We are committed to helping those saving for retirement and sustaining the success of automatic enrolment with 9.5million people now newly saving or saving more for retirement,’ said a Government spokesperson.
‘We recognise the differences in the way tax relief is delivered through net pay and relief at source arrangements.
‘Both approaches have advantages, with relief at source arrangements being particularly appropriate for lower earners.
‘NEST, which now has over 6 million members, operates a relief at source arrangement as do several other large schemes used for automatic enrolment.’
‘The pension providers also benefit in a net pay scheme because the higher rate tax relief goes into the pension scheme, so the provider earns more fees and has a bigger fund to manage. With a relief at source scheme, only the basic rate tax relief goes in.
‘I cannot believe that the Government, the pension providers and the Pensions Regulator simply don’t recognise what an injustice this is.
‘These low earners don’t even know they are losing out yet, but if they become aware of it, who can they claim against? In many cases, their employer doesn’t know about it either.
‘I believe ultimately, the pension providers and the regulator have a clear responsibility to ensure low earners are not automatically enrolled into a net pay scheme at all, unless someone puts the extra 25 per cent in for them.
‘For example, if a company has 100 workers and only 2 of them earn below £11,850, then the cost to the employer or provider of paying the equivalent of the tax relief would be relatively small and may be worth paying in order to have the other 98 higher earners’ contributions and the convenience of a net pay arrangement that does not require reclaiming higher rate relief.
‘But this needs to be transparent, and currently it is all hidden away.’
Lee Hollingworth, head of defined contribution consulting at Hymans Robertson, said the issue was a major concern as hundreds of thousands of people who are auto-enrolled are not receiving the Government tax relief they were promised.
‘It’s had disadvantages that are indefensible,’ he said, of the low earners affected. ‘Arguably they are less informed and engaged about this issue and are less likely to protest about it. The masses are not informed about it.
‘The tripling of auto enrolment minimum contributions in April this year to 3 per cent, and the planned further rise to 5 per cent by 2019, although necessary, will serve to further compound this issue for an individual that is already not receiving the tax relief to which they are entitled.’ See below for how contributions are rising.
Source: The Pensions Advisory Service
‘So, how can this issue be resolved? As our research shows a small number of providers are already able to accommodate a tax-relief at source system. For those that don’t, a sizable investment is necessary to adapt their administration system.
‘In the absence of any real movement here it must be now up to Government to correct this anomaly created through unintentional legislation and ensure that the impacted many receive what is rightfully theirs.’
Hollingworth also suggested that The Pensions Regulator might want to look at the issue when it goes through the process of authorising master trusts under new legislation being brought in this year.
Graham Vidler, director of external affairs at industry group the Pensions and Lifetime Savings Association, said: ‘We agree that this is an important issue and we have raised it with Government on repeated occasions.
‘So far, the Treasury has said that there is no “straightforward or proportionate” way of solving the problem. Clearly, the matter cannot be left to rest in this way. The best solution is for Government to reform the tax regime on this issue.
‘The anomaly in the tax legislation means that people who earn between £10,000 and £11,850 are at risk of missing out on tax relief if they are in a “net pay” scheme.
‘Fortunately, most of these people are likely to be saving in the largest automatic enrolment schemes, such as NEST, TPP and NOW that serve all employers. In the case of NEST and TPP, this problem does not arise as they are “RAS” [relief at source] schemes.
‘In the case of NOW, which is a “net pay” scheme, they will make good any shortfall if the saver contacts them about it.’
The PLSA has a ‘Master Trust Committee’, created to be the voice of master trust pension providers among its industry members.
When it was announced in October 2016, the PLSA said: ‘The Committee will set the PLSA’s strategic direction on master trust policy, promote and support the development of the master trust market, and help savers in master trusts achieve a better income in retirement.’
A number of the master trusts that offer ‘net pay’ sit on the committee. A list of the current committee members is below.
The Pensions Regulator said wider questions around tax relief were for the Treasury to address, and the question of how this related to master trust authorisation was a matter for the Department for Work and Pensions. See the box above for the Government’s statement.
On the Hymans report, a Pensions Regulator spokesperson said: ‘It is for employers to choose a pension scheme that is suitable for their workforce and this includes giving consideration to tax relief arrangements.
‘To support them we provide online information as part of our step-by-step guide to help employers to complete their automatic enrolment duties. We also provide guidance for business advisers who support employers, and to pension schemes on the importance of communicating clearly about how they manage tax relief for members.’
On its web page explaining the difference between ‘net pay’ and ‘relief at source’ to employers, the Pensions Regulator lists several schemes it says offer the latter arrangement which Hymans says do not.
The regulator said its list includes a variety of schemes, including but not limited to master trusts, which is why it does not correlate with the master trust schemes published by Hymans.
What do master trust providers say?
This is Money asked master trusts running ‘net pay’ systems for comment, and their responses are below.
‘Providers are required to work to the policy set out by Government and as a result it’s not for us to comment,’ said a spokesperson.
LifeSight (Willis Towers Watson)
‘The fact that people earning between £10,000-£11,850 cannot always claim the full tax relief they are due is a serious issue that needs to be rectified, first and foremost, by the Treasury,’ said David Bird, head of proposition development at LifeSight.
I don’t pay tax but do contribute to a pension – can I get tax relief on my payments?
This is Money columnist Steve Webb explains how some lower earners are unwittingly losing out on pension tax relief from the Government because of how their work pension scheme operates here.
‘In the case of LifeSight, switching to a relief at source method for everyone would disadvantage many more members. Without Treasury guidance and intervention, there is no simple solution to this issue.’
A spokesman for the firm agreed that the disadvantage was that higher and additional rate taxpayers would have to fill in a tax return, but not lose any tax relief.
He said: ‘Yes that’s correct. But in LifeSight’s case we don’t believe there are many, if any, members who fall into the earnings bracket that would be affected by this, so changing to relief at source is unlikely to benefit our members.
‘The other point to make is that both relief at source and net pay master trusts are available and employers choose which to enrol their employees into.
‘They tend to choose the master trusts that best suit their employees’ circumstances, which they know better than anyone else. We’ve seen instances where an employer enrols most employees into a net pay master trust because it’s the best option for those employees but will enrol a small section of lower earning employees into a relief at source master trust to make sure they benefit from the full tax relief available.’
National Pension Trust (Xafinity Punter Southall)
Dave Hodges, head of National Pension Trust, commented: ‘We recognise that this has been an ongoing issue and over the years have been contributing to the discussion with the PLSA and fully support the statement they have made today.
‘Current legislation forces providers to choose the best approach for the majority of their members. Legislation needs to change to create a truly equitable system for tax relief where all members are treated equally, and this lays firmly with HMRC.’
NOW reimburses low earners with Government tax relief they have lost, a move praised by Ros Altmann who said: ‘It is good to see one company taking the moral high ground.
‘Now:Pensions is a net pay scheme, but it has chosen to give the extra money to its low earning customers from its own pocket. None of the other net pay schemes has been willing to ensure low earners do not lose out.’
Rob Booth, NOW: Pensions director of proposition says: ‘We feel strongly that no member of the NOW: Pensions Scheme should lose out on any tax relief to which they might be entitled, which is why we have taken steps over the past two years to make up any shortfall for our lower earning members.
‘Until the Government addresses the tax relief anomaly, the only way we could do this was by putting our hands into our own pockets.
‘We use a multitude of channels to encourage our non-tax paying members to complete a very simple online claim form, and with their authority, we then liaise with HMRC to calculate exactly how much they have lost out.
‘We then credit this amount directly into their pension pots. It’s not possible to top-up members automatically, as we need to verify their individual circumstances with HMRC.’
A Scottish Widows spokesperson said: ‘We have only just inherited the master trust from Zurich, as part of the first phase of the transfer of its workplace pensions and savings business to Scottish Widows on 3 April.
‘As you would expect, we will be reviewing all the products we have acquired to ensure they continue to best meet the needs of our customers.’
Smart Pension (L&G Investment Management is investor and partner)
Smart Pension explained it was in the process of offering ‘relief at source’ and was building it into its systems so the whole process was automated and there would be no clunky ‘claiming it back’ arrangements that over-complicate the process meaning people often don’t bother.
Martin Freeman, head of Smart Pension’s product development division, said: ‘We have plans to introduce RAS this year. We’re making sure we get it right because it’s easy to trip up with RAS and mistakes can be costly.
‘We support the call to help people who most need it and are building the robust automation that is necessary for RAS.’
‘We offer both trust-based schemes using “net pay” and contract-based schemes using “relief at source”,’ said Standard Life. ‘Over 90 per cent of our auto-enrolees are in contract-based schemes so receive full tax relief on their contributions.’
‘Be careful what you wish for,’ said Kevin Wesbroom, senior partner at Aon.
‘The [Hymans] report points out that most master trusts – including The Aon MasterTrust – operate on a net pay system, rather than relief at source.
‘For anybody paying the higher rate of tax relief, this is an advantage because it means they get their full tax relief immediately and directly into their pension, rather than having to wait for the end of the tax year (and having to fill in a tax return to reclaim tax that has been overpaid).
‘One “easy” way for HMRC to solve the dilemma between low earners (who are better suited to relief at source) and higher earners (better suited to net pay) is to move everybody to a relief at source basis – forcing millions to complete tax returns to claim their higher rate relief, and experience delays in the investment of their pensions savings.
‘The danger is that HMRC decide to simplify the RAS process by just abandoning the reclaim of higher rate relief.
‘Operating a mixed system (both RAS and net pay) is not just a major administrative challenge for the master trusts – but also difficult for employers in terms of their payroll systems, deciding which members should be offered which tax system.’
‘The Aviva Master Trust operates on a net pay basis,’ said the firm. ‘The Aviva Master Trust has targeted employers with predominantly full time workers who earn more than the income tax threshold and who have previously been a member of a net pay arrangement pension scheme.
‘Therefore it was appropriate for our master trust to operate a net pay arrangement. We also offer a group personal pension on a relief at source basis which employers can choose if they feel it is more appropriate for their workforce.’
BlackRock said it didn’t have a statement on this.
Paul D Bannister, chief executive officer of Evolve, said: ‘The subject of ‘net pay’ is one that is dealt with by the Trustee of both Bluesky and Crystal and has been discussed at Trustee meetings and, I understand, is on the agenda at the next meeting in June.
‘An assessment of the membership was undertaken last year which showed up no requirement for a change but it is re-visited often.’
No response received before publication.
‘We are already in discussions with our administration providers on how to implement this functionality into their systems,’ said Mercer regarding relief at source. ‘Currently we make members aware of the implications through the scheme literature.
‘The effective operation of Mercer Master Trust’s governance and administration practices is reflected in its Master Trust Assurance accreditation.’
No response received before publication.
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