When an employee contributes to a pension scheme they get a contribution from the Government in the form of tax relief.
There are two ways that tax relief is applied as described below…
Net Pay Arrangement (NPA)
With this type of arrangement, the pension contribution and the government’s tax contribution are taken from an employee’s gross pay before tax is deducted. This reduces the amount of taxable pay that the employee pays tax on.
If an employee doesn’t pay tax, there won’t be any tax relief.
For additional and higher tax payers they receive full tax relief and therefore do not need to claim any additional tax relief via a Self Assessment return.
Relief At Source (RAS or BRAS)
Pension contributions are taken from the employee’s net pay; after Tax and National Insurance have been deducted. The pension scheme provider then claims the tax back from the government at the basic rate of 20%. This is added to the employee’s pension pot.
If an employee doesn’t pay tax, they will still receive the tax relief of 20%.
For additional and higher tax payers they will need to claim any additional tax relief via a Self Assessment return.
The type of Tax Relief is determined by the Pension Provider
How this affects your pension choice
The pension provider and scheme you choose will determine which method of tax relief is used – most pension providers will only support one type of tax relief (with just a few exceptions). The type of tax relief applied makes some pension schemes more suitable for some employees than others e.g. higher and lower-paid employees.
Summary
Net Pay Arrangement
Pros: Staff paying the higher or additional rate of tax will get their full tax relief.
Cons: Lower-paid staff that do not pay tax, won’t get tax relief on contributions.
Suitable for: Employers with staff earning over the personal allowance threshold.
Relief At Source
Pros: Suitable for staff who don’t pay any tax as they will be able to receive government tax relief on their contributions.
Cons: Employees paying the higher or additional rate of tax will need to claim back their full tax relief above the basic rate of 20% already received from HMRC via a self-assessment tax return each year.
Suitable for: Most employers, especially those with lower-paid staff and basic rate taxpayers.
Pension Salary Sacrifice
There is another form of tax relief that we have not mentioned above, this is because it is not determined by the Pension Provider but a contractual arrangement between the employer and employee in form of a salary sacrifice. In short, a salary sacrifice is where an employee contractually agrees to give up a portion of their salary in return for the cost of a benefit, in this instance pension contributions. As they do not receive this salary payment they receive both Tax & National Insurance relief via payroll, the employer also benefits from not paying Employers National Insurance on the proportion of the salary sacrificed.
But salary sacrifice must be used cautiously, as some employees may be pulled below the national living/minimum wage and entitlement to other benefits may be affected. Other considerations are that not all pension providers will support a salary sacrifice option. Also as all the contributions paid in this manner are treated as an employer contribution, if an employee is on Statutory Parental Pay, you will be responsible for paying all the contributions (e.g 8% rather than 3%) at the same level as before parental leave began without being able to deduct the sacrificed amount from the employee’s statutory pay as this would be in breach of National Minimum Wages rules.
Pros: More efficient tax relief as the amount sacrificed is not subject to Tax or National Insurance (NI). The employer can opt to add the 13.8% employer’s NI saving to the contributions in part or in full, therefore increasing the overall contributions made.
Cons: This may affect an employee’s entitlement to certain benefits. The reduced salary may affect mortgage or loan applications. Lower-paid employees will not be able to participate in the salary sacrifice arrangement as it will pull their earnings below the national living/minimum wage.
Applying the wrong tax relief in payroll
Believe it or not, this does happen! We have seen on occasions payrolls transferring to us, that have been run in-house or by other outsourcing service providers, where the wrong tax relief has been applied for the pension scheme in place. This results in the employees not receiving the correct tax relief, which can mean that as an employer you have not met the legal minimum contributions required by law or that the employees have received double tax relief which they may be asked to pay back to HMRC at a future date.
For more help with choosing the right scheme read The Pensions Regulator guidance on What to look for in a pension scheme.
For further information on Salary Sacrifices see the following links for HMRC guidance and Unbiased.
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