If you do not take up the offer of a workplace pension, your boss is laughing all the way to the bank at your expense.
Under the government-mandated auto-enrolment workplace pension rules, unless you opt-out of your workplace pension scheme you will automatically pay in 4% of qualifying earnings. The government then tops that up with 1% tax relief and if you’re a higher rate taxpayer you can claim the additional 20% tax relief via your annual tax return. Provided you pay in the required 4% your employer MUST pay in 3%. Say you’re earning £24,000pa. Contributions will be made on your qualifying earnings of £17,760 a year. Your monthly contribution will be £74.00 which includes tax relief of £14.80 so the net cost to you is £60pm. To that your employer must add another £44.40 per month making a total monthly contribution of £118.40. Why would you not want your boss and the government to put that total amount of £710.40 into your pension pot every year? And of course, as your pay increases, the government and employer contributions to your pension will also increase.
There are two ways in which you can get tax relief on your pension contributions, either by a ‘relief at source’ or a ‘net pay’ arrangement.
Relief at source
With a relief at source arrangement your employer deducts tax from your taxable earnings as normal. Then they deduct 80% of your pension contribution from your net (after-tax) pay and send this to your pension provider. So, tax is deducted from your pay before your pension contribution. Your pension provider then claims the other 20% in tax relief direct from the government. If you live in Scotland and pay tax at the Scottish starter rate of 19%, you still get tax relief on your pension contributions at 20%. This way is better for low-paid people who don’t pay any tax as they still get tax relief. However, with this arrangement, people who pay higher rates of tax than 20% will have to claim the additional tax relief through their tax return or direct from the tax office.
Net pay
With a net pay arrangement your employer deducts the full amount of your pension contribution from your gross (before-tax) pay. You then pay tax on your earnings net of your pension contribution, so your tax bill is lower and you have higher take-home pay. This way, although you have paid the full amount of your pension contribution yourself, you receive the tax relief by paying slightly less tax. With this method, whatever rate of tax you pay, you receive full tax relief without having to claim it, which is obviously a hassle-saver if you’re a higher rate taxpayer. However, if you don’t pay tax, this method means you won’t receive any tax relief on your contributions – not good!
Tax relief if you don’t pay tax
Workers who earn less than the personal allowance (£12,500 in the tax year 2020-21) and therefore don’t pay tax won’t receive tax relief if their employer operates a net pay arrangement. This is because under a net pay arrangement the full amount of the pension contribution is taken from your pay before tax is applied. Instead of getting tax relief added to the pension contribution, you get tax relief by having a lower tax bill. But if you don’t pay tax, there is no tax bill, so no tax relief.
For example:
| Net pay arrangement | Relief at source arrangement | |
| Income | £10,400 (£200 a week) | £10,400 (£200 a week) |
| Contribution into pension | 3%, £6 a week | 3%, £6 a week |
| Taken from pay | £6 | £4.80 |
| Tax relief | £0 | £1.20 |
While both arrangements would put £6 into your pension, with a net pay arrangement, the full £6 is taken from your pay. You can’t claim any money back from HMRC and you’ll have slightly less take-home pay compared to using a relief at source arrangement. If your employer hasn’t set up a workplace pension scheme yet, raise this issue with them and ask them to consider a scheme which operates a relief at source arrangement. However, if the scheme is already in place, your options are limited because your employer must operate the same method for all staff in the scheme. Don’t be tempted to leave the scheme to set up one of your own as you’ll lose any contributions that your employer makes – which will be more than the tax relief you have lost. You could ask your employer if they would be prepared to top up your scheme by the tax relief figure, but there is no requirement for them to do this.
How do I know which type of tax relief arrangement my employer has?
The simplest way is to ask your HR department, if you have one, or whoever does the payroll for your employer. Ask whether the scheme is operated as a net pay arrangement (full pension contribution taken from pay) or a relief at source arrangement (lower pension contribution taken from pay and tax relief claimed direct from government by your pension provider).
So, when do you want to retire?
The state pension age has increased in recent years and may well increase again in the future. That is why you need a personal private pension such as auto-enrolment provides. If you want to retire before state pension age then short of winning the lottery or receiving a large inheritance, it’s probably your only hope.
