A new pensions tax relief top up to benefit low earners
A new pensions tax relief top-up will help over a million low paid workers
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More than a million workers are in line to get a pensions tax relief top-up, after the government unveiled a system to correct the so-called “low earners anomaly”.
Workers on low incomes that are contributing to a “net pay” pension scheme will be able to claim a top-up worth an average of £53 a year. An estimated 1.2 million individuals could benefit, 75% of whom are women.
The new system, announced in the Autumn Budget, will correct a long-standing inequity between those on low incomes in “relief at source” pensions versus “net pay” schemes.
Chancellor Rishi Sunak also revealed in his Budget (opens in new tab) that the cap on pension (opens in new tab) fees will be placed under review, meaning savers could be hit with higher costs in future.
What is a “net pay” pension scheme and who will get the pensions tax relief?
Workers that pay into a net pay pension but earn less than the personal income tax threshold (£12,570 for 2021-22) do not receive pensions tax relief, while those who contribute to a relief at source scheme do benefit from tax relief.
Experts have used lots of words over the years to describe this discrepancy, from loophole and quirk to a full-blown scandal. It has particularly harmed working mothers who take on part-time hours.
James Jones-Tinsley, a pensions specialist at the consultancy Barnett Waddingham, said the government was finally meeting its 2019 manifesto commitment to resolve the pension tax relief loophole.
While details were hidden in the Budget documents - and not announced in Sunak’s speech - Jones-Tinsley said the new system would “directly support low-paid workers, mostly women, harmed by the tax relief discrepancy in workplace pension schemes, putting more money into the retirement pots of the people who need it most.”
The system will be introduced from April 2024. The Treasury estimates that paying the top-ups will cost the government £25 million between 2025 and 2027.
Becky O’Connor, head of pensions and savings at the investment platform interactive investor, said: “The correction puts right a quirk of the pension system that unfairly penalises low earners saving in ‘net pay’ workplace schemes.
“The type of pension scheme someone is in is not generally something within an individual’s control, so lower paid workers in this type of scheme are missing out through no fault of their own.”
Meanwhile, Tom Selby, head of retirement policy at AJ Bell (opens in new tab), said that while he welcomed the fact the Treasury had finally settled on a solution to the “scandal”, the slow pace of delivery would likely be criticised.
He added: “It is also not exactly clear what information those affected will need to provide in order to get their average £53 rebate. It is vital this process is made as straightforward as possible to ensure maximum take-up.”
What is happening to pension fees?
Sunak also announced in the Budget that the government would “consult on further changes to the regulatory charge cap for pension schemes”.
The cap applies to default funds in workplace pension schemes, which most savers invest in - unless they actively choose to invest in a different fund. It is currently set at 0.75%. So, for someone with a £10,000 pension pot, the fee they pay for their investment fund would be no more than £75 a year. The average fee for a default fund is currently 0.48%.
According to the Treasury, changing (or increasing) the cap could enable pension schemes “to support some of the most innovative businesses”, such as infrastructure projects or green initiatives.
Renny Biggins, head of retirement at TISA (The Investing and Saving Alliance), said a slight increase to the charge cap could be appealing to consumers if it meant a potential uplift in returns. “This needs to be approached carefully to ensure consumers remain protected and it will be interesting to see how this fits in with the [regulator’s] discussion paper on value for money.”
The consultation to change the charge cap will take place before the end of the year. The Treasury said it could be amended to “better accommodate well-designed performance fees to ensure savers can benefit from higher return investments”.
Yvonne Braun, director of long-term savings and protection policy at the Association of British Insurers (opens in new tab), explained how a higher cap could result in better returns: “Pension savers should be able to benefit from the greater return potential of investing in illiquid assets, such as infrastructure and renewable energy projects. Many of these assets are held in funds managed by private equity and venture capital firms, where performance charges are commonplace, and providers and pension schemes have historically shied away from investing in such funds because of concerns they would breach the 0.75% cap.”
However, Becky O’Connor at interactive investor urged caution. “The chancellor is after our life savings to fund UK infrastructure. Rather than simply increasing taxes to pay for it, the government is considering changes to the pension charge cap: an indirect and possibly unnecessary measure,” she said. “There is always the risk that these higher returns won’t materialise – and then people end up paying more for their pensions for no good reason.”
Ruth Emery is contributing editor at The Money Edit. Ruth is passionate about helping people feel more confident about their finances. She was previously editor of Times Money Mentor, and prior to that was deputy Money editor at The Sunday Times. A multi-award winning journalist, Ruth started her career on a pensions magazine at the FT Group, and has also worked at Money Observer and Money Advice Service. Outside of work, she is a mum to two young children, a magistrate and an NHS volunteer.
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