When will low-income earners get tax relief on pension contributions?

The Government has introduced a new pension supplement scheme for people on low incomes.

People who earn less than the personal allowance of £12,570 do not get tax relief on pension contributions.

The new plan will pay the tax relief into bank accounts. Could you explain how the plan works?

SCROLL DOWN TO FIND OUT HOW TO ASK STEVE HIS PENSION QUESTION

Steve Webb answers: A letter from HM Revenue & Customs is rarely a cause for celebration, but next year more than a million low-paid workers should be on the lookout for a letter offering to make a modest payment into their bank account.

The issue affects a particular group of workers who can say “yes” to the following three questions at the end of the current fiscal year:

– Did you have taxable income less than £12,570 (after taking into account pension contributions)?

– Did you make personal contributions to a workplace pension?

– Does your pension offer tax relief through the “net payment” system?

The answer to the third of these questions should already be clear to regular readers of my column, but as a quick reminder, there are two ways in which pension savers can benefit from a tax reduction on their contributions.

The first is known as Relief at Source (RAS), where contributions are made from your net salary, after having paid taxes.

This is the approach taken for personal pensions and some workplace pension schemes such as Nest.

In this case, HMRC pays the basic rate tax relief directly to your pension fund.

Note that these low-wage workers *do* get tax relief even if their income is below the tax threshold.

The second is the Net Pay Agreement, where contributions are taken from your gross salary and your income tax bill is calculated from what is left.

In this case, the money you put into your pension should benefit from a tax reduction, because your taxable income is reduced as a result of the pension contribution.

This approach is used for most trust-based occupational pension schemes.

In most cases, the outcome for the individual will be broadly similar regardless of whether the RAS or net payment approach is used.

But for many years there has been concern that a group of workers could lose out if their employer had chosen a plan that provided tax relief through the Net Pay route.

These are workers whose salary is below (or just above) the tax threshold.

It is easier to see this through a numerical example.

Consider the case of a worker earning £10,000 a year who has been automatically enrolled in a workplace pension and wants to put £500 into his pension.

If they are a member of a RAS scheme, they can simply pay £400 of their take-home pay and HMRC will add £100 tax relief, making a total of £500.

But if they are members of a net pay plan, paying pension contributions will have no impact on their tax bill because their earnings are below the tax threshold.

This means it costs them £500 to deposit £500 into a pension scheme, £100 more than their counterpart in a RAS scheme.

After much pressure, the Government finally accepted that it was unfair to penalise these lower-income workers for a decision over which they had no control, as it is their employers who opt for one plan or another, not them.

Thus, in July 2022 and after a consultation period, it was announced that the The government would implement a repair plan to help these people.

The way the scheme will work is that at the end of 2024/25, HMRC will analyze membership information from pension schemes that provide tax relief through the Net Pay Arrangement.

It will identify workers who earn below the tax threshold (or just slightly above it) and who made personal contributions to the plan.

HMRC will then write to you asking for your bank details and make a payment directly into your bank account (not your pension).

The payment amount will simply be the income tax owed on the pension contribution.

So, for example, if someone has paid £500 into an occupational pension using the Net Payment Arrangement, HMRC will credit £100 into their bank account.

This means they will end up with £500 in their pension, but with a net cost of £400 – the same as someone on a RAS scheme.

In terms of time, HMRC simply says: “Payments will be made as soon as possible after the fiscal year in which the contribution is paid.”

HMRC estimates that there could be Around 1.2 million potential beneficiariesand around three-quarters of them are likely to be women.

Once a person has provided bank details once, they should not need to do so again.

As long as they continue to earn below the tax threshold and contribute to a net pay plan, they will continue to receive annual payments.

What is slightly surprising is the relatively low annual cost borne by HM Treasury for payments under this scheme: just £10m in 2025/26 and £15m in 2026/27.

The reason the figure is so low is that the Government assumes that the scheme will fail to reach a significant proportion of those it targets.

In part, this is because the low-paid workforce may be particularly transient and therefore up-to-date contact details may not be available for some.

Election money

But a bigger challenge is that some people may simply not respond to the letter (perhaps if the payment is too small) or think it is a scam.

It is therefore very important that, when the letters begin to be sent next year, HMRC launches an advertising campaign to reassure letter recipients and also to encourage people who are entitled to come forward but who may not have received a letter.

Hopefully, HMRC will also help ensure that people can differentiate between genuine letters on this issue and scammers simply trying to obtain bank details.

HMRC already has a section on its website on how to tell if a communication that purports to come from oneself is genuine.