Tax relief is one of the biggest plus points that come from saving into a pension. The money that you save each month gets topped up by the Government, helping you build a more significant pot to see you through retirement.
It’s one area that has long been under review though, due to the fact that the tax relief is paid based on your rate of Income Tax.
As a result, the top earners enjoy more tax relief on their contributions than basic rate taxpayers.
What’s more, it’s emerged in recent years that some of the lowest earners, who bring in less than the personal allowance ‒ the amount you can earn each year before having to pay Income Tax ‒ aren’t getting any tax relief at all.
How are my contributions taken?
This is an issue we’ve covered at length on loveMONEY, but ultimately it comes down to how your contributions are taken by your employer to pay into your workplace pension.
Some schemes claim relief at source, which essentially means that your contributions are taken from your pay packet after tax has been paid, with the pension provider then claiming the tax relief from HMRC.
The alternative is a net pay arrangement, where the entire contribution is taken from your pay packet before tax is paid. The idea here is that you get tax relief automatically based on your marginal rate.
That’s great if you actually pay tax, but if you don’t earn above the £12,500 personal allowance then you miss out on that tax relief.
A smaller pension pot
This is a big deal. New analysis out this week from Quilter has shown that since November 2019 ‒ when the Government acknowledged the issue and promised to put things right ‒ low earners have missed out on around £142m in tax relief.
In the last tax year alone, 1.5 million people lost out on an average of £62.60.
Now I know what you’re thinking. A little over £60, is that it? And you’re right ‒ on the face of it, that’s not a lot of money.
But this is a pension we’re talking about. That money is going to be invested for decades, and the compound growth will quickly add up.
What appears to be a small sum can end up making a huge difference to the eventual size of your pot, and therefore your standard of life in retirement.
Get a move on!
It’s clearly a positive that the Government has realised the problem here. But it’s showing no desire to actually put it right any time soon.
Every year that this drags on is going to have a big impact on millions of people’s retirements ‒ it’s not something that can simply be put off for a bit, with no repercussions.
The Government consulted on the issue a year ago now, but since then we’ve heard nothing. That’s simply unacceptable.
Do we even need a law change?
It’s worth highlighting that some argue that we already have a solution in place for this particular issue.
LEBC, a firm that advises businesses when setting up workplace pensions, argues that there is already a simple solution.
Essentially the idea is that firms run two pension schemes in parallel.
Those who are lower earners are placed in the scheme which offers relief at source, while the higher earners go into a scheme where deductions are made before tax is calculated.
The added perk here is that as they get relief at the highest rate of tax payable, they don’t then need to make a separate claim to the taxman.
It’s clearly a smart idea, an innovative way to work around the problem.
But ultimately it relies on the employer recognising this issue and taking steps to ensure their staff aren’t caught out by it. If you aren’t lucky enough to work for such a boss, then you’re stuck missing out on that tax relief, which is undoubtedly unfair.
So let’s hope more bosses adopt this approach in the short term, but ultimately the only real solution has to come from the Government.