How does tax relief work

How does tax relief work?

There are two ways that members may receive tax relief on their pension contributions:

Net pay arrangement

The Lewis Workplace Pension Trust is based on the net pay arrangement whereby the employer takes members' gross contributions away from earnings before arriving at taxable pay. Members only pay tax on what's left. This means members get full tax relief unless they don't pay tax, e.g. because, after allowances, they earn less than the starting rate for income tax.

Under a net pay arrangement, lower paid workers earning less than £11,850 (2018/19 figure) may be disadvantaged as they won't receive tax relief on their contributions as their earnings are below the starting rate for income tax. This doesn't affect the amount of money that goes into the pension scheme, but will impact their take-home pay compared to a scheme using relief at source.

For example, under a net pay arrangement, a member who earns £10,400 (£200 a week) and pays a contribution of 1% will have the full £2 a week deducted from their pay and paid into their pension. There is no tax due from HMRC and the member will have less take home pay than under relief at source.

Relief at source

The alternative is the relief at source arrangement whereby the employer takes members' contributions after taking tax from member’s pay. This means a lower pension deduction is taken from their pay. The pension provider then adds basic rate tax relief (currently 20%) to members’ pension pots. Members who pay higher rates of tax can only claim any additional tax relief via their Self-Assessment tax return.

Under a relief at source arrangement, the same member who pays a 1% contribution would have a lower pay deduction of £1.60 a week deducted from their pay and paid into their pension. The scheme would then claim £0.40 from HMRC so that a total of £2 a week is paid into their pension but only £1.60 deducted from pay.

 

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