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How we can “level up” on pension contributions for the low paid

Hetty HughesPensions are often synonymous with complexity, particularly the tax relief system in which they sit. The success of automatic enrolment (AE), which has seen 10.2m more people brought into pension saving, can be attributed to many things, and surely one of them is simplicity. For instance, the current AE statutory contributions of 3% employee, 4% employer, 1% government is a clear way to incentivise people to save for the long term.

When AE was first introduced in 2012, only 40% of private sector workers saved into a workplace pension; now 86% do. But other things have changed too. In 2012, the personal allowance for those under 65 was £7,475, which was under the initial AE earnings threshold of £8,105. That meant that there were very few people opting into pension saving who were also non-income taxpayers. Now, the personal allowance is £12,500, 25% greater than the earnings threshold, and around 3m people who are not income taxpayers (at the point of saving) are contributing towards their pension.

Why does this matter? Because irrespective of whether you pay income tax, the government understands the need to incentivise pension saving for all. Although this is called ‘tax relief’ non-taxpayers can also claim the benefit on pension contributions This already happens for those non-income taxpayer savers in relief-at-source (RAS) workplace pension schemes, where relief is given at the basic rate of 20% on contributions. It also happens for people who are not in paid work (on contributions of up to £2,880). However, it does not happen for more than 1.6m people who are in net pay arrangement schemes. This is because in these schemes, the mechanism for giving this tax relief is immediate, and based on your marginal rate of income tax, which, for those who are not income taxpayers, will be 0%. This effectively means that for those impacted, pension saving is costing them 25% more than if they had been in a RAS scheme. This issue is known as the “net pay anomaly”.

What seems a niche and techy pensions issue now affects millions of people, and the number of impacted individuals will only increase once the expected expansion of the eligibility for AE (from the age of 18, and from the first pound earned) comes into effect. Of those currently affected, 75% of them are women[1] and the prevalence of this issue continues to exacerbate the gender pensions gap, which was recently estimated to be over 40%[2]. It is probable that this anomaly disproportionately impacts other people with protected characteristics, such as ethnic minorities, disabled people and carers, who are statistically more likely to be in low-paid or part-time work.

After years of pressure to fix this anomaly, the Conservative Manifesto commitment to review solutions to the issue was welcomed by the industry and led to a call for evidence which closed today.

This is a welcome start, and was an opportunity for our industry to demonstrate the positives, but also the hurdles of the possible solutions proposed by HMT and HMRC. Clearly, rectification of this issue is tricky; if it wasn’t, a remedy would already have been implemented. The solution we believe lies with HMRC, the only entity (other than the individual themselves), who has complete knowledge of a saver’s tax position. Other proposed approaches which utilise the employer, payroll provider, or pension scheme fall short on this vital point, and are either partial solutions with insufficient coverage, or would remove the Government top up for low paid savers altogether.

HMRC’s Real Time Information (RT) system could be used to identify the affected individual, and refund them the relief they have lost out on – this would put them on a level playing field with those in RAS schemes. The RTI solution works for all individuals, current and future savers, is dynamic to changes in circumstance, builds on HMRC’s existing systems, doesn’t overburden small employers and administrators and removes potential anomalies that could arise from other proposed approaches. This would also be a two-birds-one-stone approach– in July this year HMRC launched its 10-year strategy, which aims to create “a tax system fit for the challenges and opportunities of the 21st century”.  This is a step on the journey to efficient, routine use of personal tax accounts to maximise people’s management of their tax position, and improve HMRC’s ability to collect taxes.

The recent COVID job retention and support schemes have proven that HMRC are able to tackle difficult, but crucial, tasks at speed. Including pension contributions in some of these schemes has also demonstrated the Government’s commitment to helping the low paid save for retirement. Enabling the same people to receive a Government contribution on their savings should be next.

[1] https://www.parliament.uk/business/publications/written-questions-answers-statements/written-question/Lords/2020-03-18/HL2729/

[2] https://prospect.org.uk/article/what-is-the-gender-pension-gap/

Last updated 13/10/2020