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Pensions tax changes: What is the Net Pay anomaly?

July 28, 2022

On July 20, the government published a change to the pension tax system that will provide more than a million low-paid workers with a boost to their savings.

The change has been implemented to correct the so-called Net Pay anomaly. This has been described as a “quirk” of the system, where some people saving through a Net Pay Arrangement (NPA) have missed out on the 20% government top-up to their pension pot.

In this article we provide an overview of the changes being introduced and explain what they mean for affected employees and employers.

What are Net Pay Arrangement schemes?

Employee pension schemes are typically structured as either Net Pay, where contributions are taken from pre-tax wages, or Relief at Source, where they are taken from post-tax earnings and government tax relief is automatically applied by HMRC.

Many employers offer their workers the opportunity to join NPA schemes. These are typically co-ordinated via a pension provider and are often set-up as part of an employer’s auto-enrolment obligations, with NPA schemes regarded by some as carrying a lower administrative burden.

What is the Net Pay anomaly?

In Relief at Source schemes, members automatically receive a 20% tax relief ‘top-up’ from the government on an 80% contribution drawn from their taxed income. This tax relief applies even if an individual earns below the income tax threshold, known as the personal allowance (currently £12,570).

In Net Pay Arrangements, however, 100% of pension contributions are taken from pre-tax gross wages. Earners above the income tax threshold therefore benefit from tax relief on their contribution – which equates to 20% for basic rate payers. This brings their contribution in line with those saving via Relief at Source schemes.

For those earning below the income tax threshold, however, tax relief is effectively applied at a rate of 0%, meaning they miss out on the 20% government top-up. In order to make the same pension contribution as someone in a Relief at Source scheme, a member of a NPA scheme would therefore need to invest more from their take-home pay.

Who does it affect and how will they benefit?

The government estimates that 1.2m people earning below the income tax threshold will benefit from the legislation changes. It says that three quarters of those are women, with 11% based in the North-West and Merseyside and 12% in London.

The average beneficiary will receive an extra £53 a year, while around 200,000 people are expected to see their take-home pay increase by £100. An example of how the changes could affect pension savers is available on the HMRC website.

Why is this happening now?

The government first announced its intention to address the Net Pay anomaly in its Autumn 2021 budget and the legislation was then published on July 20, 2022. However, the issue has been bubbling away for several years, with savers impacted since 2015 and critics long calling for action.

In 2018, pension industry experts raised the issue with then Chancellor Philip Hammond, demanding “an end to the scandal” and requesting that he urgently addresses the situation through legislative reform.

One of the signatories to the letter was former pensions minister Baroness Altmann, who has been a particularly vocal campaigner on the issue. The Conservative Party subsequently pledged to resolve the issue in its 2019 manifesto.

When will it come into effect?

The changes were ushered in though the introduction of a new section (193A) to the Finance Act 2004. While this has now passed into legislation, it will not take effect until April 6, 2024.

At this point, HMRC will directly notify individuals who are eligible for the top-ups. Beneficiaries will then need to supply their banking details in order to receive the payments, which will not be made until 2025.

As an employer, what do I need to do?

Firstly, clarify with your pension provider which structure your workplace pension scheme follows. It is possible, after all, that companies with NPA schemes in place are unaware that some employees are being caught in this anomaly.

From an accounting perspective, there is no action required of employers as eligible employees will liaise directly with HMRC on the issue.

However, communication is fundamental in building engagement on issues such as pensions, so if your scheme is NPA based, then you may wish to update employees on the nature of the recent changes, highlighting any potential implications for staff and possibly clarifying what needs to happen for any expected top-up payments to be received.


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