The Low Incomes Tax Reform Group (LITRG) is calling for more help for the low paid because of the increase in the cost of auto enrolment. This should include the Government both allowing those on the lowest pay to salary sacrifice and also finding a way to overcome the lack of tax relief for those in certain pension arrangements, says LITRG.
Workers who have been enrolled automatically into a workplace pension, from 6 April 2018, may be required to increase the amount of their minimum contributions from one per cent to three per cent of their qualifying earnings. From 6 April 2019, their minimum contributions will increase again to five per cent. In 2018/19, qualifying earnings are those over £116 per week up to an upper limit of £892 per week (£503 and £3,863 a month).
LITRG Chair Anne Fairpo said:
“The increase in contribution rates makes auto enrolment a much bigger consideration for the lowest paid. The fact that many people on low incomes cannot obtain tax relief is a huge disincentive – it makes auto enrolment effectively 20 per cent more expensive for them.”
The lack of tax relief affects those who earn over the £10,000 needed to trigger auto enrolment, but below (or not very much above) the income tax threshold (currently £11,500 and set to rise to £11,850), who are enrolled in a ‘net-pay’ pension scheme rather than a ‘relief at source’ scheme.1
Consider Marcie, who earns £225 per week. In 2018/19, she will pay contributions based on £109 (£225 less £116) each week. Over the course of the year Marcie will need to put in £170.04 to her pension if she is in a ‘net pay’ scheme, whereas she would only need to put in £136.03 if she was in a ‘relief at source’ scheme – the rest will be paid into her pension pot by the Government as tax relief. From April 2019, when contribution rates increase to five per cent this £34 pension ‘penalty’ for Marcie will increase to £56 (assuming all else remains the same).2
If Marcie’s £225 earnings are derived from being on or near the minimum wage, then there is a double hit for her because she also cannot salary sacrifice to save 12 per cent National Insurance, if such an arrangement would take her pay below the level of the applicable minimum wage rate (£7.83 per hour in 2018/19 for those aged 25 and over).3
Anne Fairpo said:
"One of the concerns about allowing the lowest earners to sacrifice salary has been the risk of their pay dropping below the point at which entitlement to contributory benefits is triggered (the Lower Earnings Limit – £116 per week in 2018/19). In our view, the ‘risks’ to such employees of using salary sacrifice are largely overstated and there would be nothing to stop the Government building in a safeguard to stop salary sacrifice pushing an employee's salary below the Lower Earnings Limit to ensure their contributions record remains protected.
“We would urge the Government to think about allowing those on the lowest pay to salary sacrifice and also find a way to overcome the lack of tax relief.”
LITRG suggests that by using PAYE real time information data, HMRC could match pension contributions deducted via the payroll to individuals’ records and reconcile where those in a ‘net pay’ arrangement have not received tax relief but would have done so under a ‘relief at source’ scheme. The relief they have lost out on could be paid to the pension scheme in which they are enrolled.
- Under 'net pay’ arrangements, the pension amount is deducted from an individual’s pay before tax is calculated (meaning the employee receives tax relief there and then). Under 'relief at source' arrangements – the pension contribution is deducted after tax is calculated and HMRC later send the tax relief to the pension scheme. Under ‘relief at source’ arrangements, members of pension schemes who do not pay income tax are nonetheless permitted to basic rate tax relief (20 per cent) on pension contributions up to £2,880 a year. In practice this means that HMRC will top up a net contribution of £2,880 to a gross £3,600.
- For 2018/19, the £34 represents the annual equivalent of the difference between £109 x three per cent and £109 x 2.4 per cent (the amount required from the employee if tax relief is factored in). For 2019/20, the £56 represents the annual equivalent of the difference between £109 x five per cent and £109 x four per cent.
- In a ‘salary sacrifice’ arrangement, a worker gives up the right to some salary in exchange for an employer pension contribution. Under normal circumstances, this salary would be subject to National Insurance, even if it is then paid by the worker into a pension scheme. Employer pension contributions are not subject to National Insurance, so this arrangement saves most workers around 12 per cent in National Insurance.