Auto enrolment isn’t new, employers are required to automatically enrol all eligible workers into a pension scheme. It requires a minimum total contribution, made up of the employer’s contribution, the worker’s contribution and tax relief. The government offers financial incentives to encourage individuals and employers to save for their retirement, one of these is pensions income tax relief.
Tax relief is given on your pension contributions at the highest rate of income tax you pay, meaning:
basic-rate taxpayers get 20% pension tax relief
higher-rate taxpayers can claim 40% pension tax relief
additional-rate taxpayers can claim 45% pension tax relief.
In Scotland, income tax is banded differently, and pension tax relief is applied in a slightly different way:
Starter rate taxpayers pay 19% income tax but get 20% pension tax relief
Basic rate taxpayers pay 20% income tax and get 20% pension tax relief
Intermediate rate taxpayers pa 21% income tax and can claim 21% pension tax relief
Higher-rate taxpayers pay 41% income tax and can claim 41% pension tax relief
Top rate taxpayers pay 46% income tax and can claim 46% pension tax relief.
The way tax relief is obtained depends on the type of pension scheme you are saving into, and it may be useful to check with your scheme provider to see what method it uses. There are two main ways:
Relief at source scheme – pension contributions are deducted after the tax calculation has been performed
Net pay arrangement scheme – pension contributions are deducted before the tax calculation is
‘Relief at source’ (RAS) applies to all personal pensions and some workplace pensions. The pension contributions in a RAS scheme do not affect the calculation of taxable pay. Pension contributions are deducted net of tax at the basic rate (currently 20%). So, for example, a net pension contribution of £80 means that £100 is credited to the pension scheme – £80 from the individual and £20 from the pension provider. The scheme administrators will later claim the basic rate tax relief back from HM Revenue & Customs (HMRC).
All individuals get the benefit of tax relief at the basic rate in a RAS scheme, regardless of whether they are a taxpayer or not. But the downside of this type of scheme for higher paid workers is that if they are a higher- or additional-rate taxpayer they must complete a self-assessment tax return to receive the extra relief due to them.
The ‘net pay arrangement’ is used by some workplace pensions and all public sector pension schemes and generally does not require you to do anything to get full tax relief. Your pension contributions are deducted from earnings before income tax is calculated, which means that you receive the benefit of tax relief at the point the contributions are deducted.
For example, an employee decides to contribute £100 to the pension scheme each month. £100 is deducted from the employee’s gross pay, reducing the employee’s taxable pay, which reduces tax due by £20 (for a basic rate taxpayer). The employee’s actual contribution to the pension scheme is £100.