Auto enrolment - choosing a pension scheme for your PA

If you are a brand new employer or are an existing employer that is setting up a workplace pension for the first time, did you know that your choice of pension scheme can affect whether or not your PA gets a government contribution to their pension pot?

Depending on how much your PA earns, they may be affected by a growing issue within the auto enrolment programme, whereby workers who earn over the £10,000 per annum needed to trigger auto enrolment, but below (or not very much above) the income tax personal allowance (£11,850 in 2018/19) and who are enrolled in a ‘net pay’ pension scheme rather than a ‘relief at source’ scheme, do not get tax relief to help make up their contribution amount.

As a bit of background, there are two ways that an employee’s pension contributions can be taken from their pay, depending on the type of pension scheme chosen by their employer:

  • Under ‘net pay arrangements’ (NPA) where 100% of the pension contribution due under auto enrolment is deducted BEFORE tax is calculated on wages (meaning the employee in theory, should receive tax relief there and then)
  • Under ‘relief at source’ (RAS) arrangements – where 80% of the pension contribution due under auto enrolment is deducted after tax is calculated on wages and HMRC later send an extra 20% (representing tax relief) to the pension scheme.

Under RAS arrangements, those who do not pay income tax are nonetheless permitted to this 20% tax relief on pension contributions up to £2,880 a year. However, this tax relief is not available to non-taxpayers in NPA schemes.

Example

Jo earns £950 per month. Her employer pays the minimum amount into her workplace pension scheme, so Jo must put £13.41 of her pay into it every month (£950 - £503 @ 3%). The pension scheme operates under NPA, so her employer deducts the pension contribution before calculating tax (but after calculating National Insurance). This means Jo’s earnings are taken to be £936.59 for tax purposes instead of £950. However, as Jo’s earnings fall below the threshold for paying income tax, this reduction in taxable income makes no difference and she gets no tax relief on the contributions paid.

If Jo was in a RAS scheme, her taxable employment income would be £950 a month. She would still not pay any tax, but she would only have to put 80% of £13.41 (i.e. £10.72) of her pay into her pension pot – the rest is paid into it for her by the government. She is therefore £2.68 a month, or £32.18 a year, better off under a relief at source scheme.

The government-backed pension provider, NEST, uses a relief at source scheme, as do a few other auto enrolment scheme providers.  However, the vast majority of auto enrolment trust based schemes use net pay arrangements.

Many organisations, including LITRG, are calling on the government to change the rules as we believe that the type of pension scheme a worker is in, should not result in such differing and unfair outcomes. We hope that there will be a change in the rules soon, particularly, as the employee contribution rates are set to change in April 19 from 3% to 5% and the amount that low income workers in net pay arrangements lose out on will increase.

In the meantime, we know that this will be a relevant consideration for many employers out there who want to do the right thing by their workers and we wanted to help raise awareness. More information can be found on The Pensions Regulator’s website. We also cover it in our website guidance on auto enrolment.

(01-10-2018)