Re-arranging deckchairs on the Titanic and the thorny problem of Net Pay vs Relief at Source

Blog 14 Sep 2020 By Matthew Masters

With a focus on defined contribution schemes, a “call for evidence”, announced at Budget 2020, is seeking views on an unintended consequence in the way pension tax relief operates.  While not well understood, around 1.75 million lower paid workers, of whom women represent around 75%, could be affected.  The government is rightly concerned about this and keen to explore the issues to understand what options for change may exist.  Responses are invited by 11pm on 13 October.  However, is this simply diverting attention and energy from the bigger question?


Pensions were originally provided through workplaces, which meant tax relief on pension contributions could be made from income that had not yet been taxed (a “Net Pay” arrangement).  The introduction of personal pensions, however, meant another system for administering pensions tax relief was required, as pension contributions could now be made from taxed income (“Relief at Source”, or “RAS”). 

In a RAS scheme, the employer deducts only 80% of the pension contribution from the employee’s salary; the scheme then adds an amount equal to basic rate tax relief, which it then reclaims from HMRC. The key point to note is that the scheme adds this top-up to the employee’s contribution whether or not the employee is earning enough to pay tax in the first place.

How does this affect individuals?

For individuals in the basic rate income tax band or above, this only affects the paperwork.

However, for those who earn less than the personal allowance (currently £12,500), there is a real impact.

By way of example, both John and Suzie earn £10,000 and have the same level of take-home pay.  However, Suzie has a larger contribution going into her pension pot:

  • Suzie is a member of a RAS scheme, and it is therefore assumed, for pension purposes, that she is at least a basic rate taxpayer.  So, while Suzie also contributes £800 into her pension pot, her pension provider claims £200 in tax relief from HMRC to top the total pension contribution up to £1,000.    
  • John contributes to his pension scheme through a net pay arrangement.  Over the year, £800 is deducted from his pre-tax salary of £10,000 and £800 goes into his pension pot.  This leaves John with take-home pay of £9,200.  Under this arrangement, John has missed out on £200 of tax relief.

As members of RAS pension schemes are granted basic rate tax relief of 20% on pension contributions of up to £2,880 a year, HMRC would top up a net contribution of £2,880 to £3,600.  Over an entire working lifetime, and assuming 3% net investment growth, the difference this makes could be worth more that £50,000, or the equivalent of four years’ salary.

A way forward?

The Government’s position is that any solution should be simple (easy to explain), deliverable, sustainable and proportionate.  This is no easy task.

For example, mandating use of RAS for defined contribution pension schemes, thus ensuring all low earners receive the top-up on their pension savings, would have significant appeal in terms of fairness and simplicity.  However, such a proposal would not be without its challenges, including:

  • potential significant investment in systems;
  • changes to scheme and payroll processes; and
  • a potential review of employment contracts to properly understand the impacts on employees.


As we are all aware, the Exchequer’s purse has taken quite a hit these last few months.  Consequently, it seems to me highly likely that the question of whether the c.£40bn estimated cost of pensions tax relief is correctly targeted, or even required at all, will be firmly on HM Treasury’s radar. 

I believe that encouragement is needed to get people saving for their old age, so they don’t simply fall back on State support.  Nevertheless, there is clearly an attraction to the approach of “I can reduce pension tax relief now and leave the fall-out to a future Government”.

That is not to say that a more fundamental review of pension tax relief distribution wouldn’t be merited, and one that is borne of cross-party long-term consensus.  For example, rather than providing tax relief at an individual’s marginal rate, equating this to a single rate (of say 30%) should have the effect of inducing basic rate tax-payers to contribute more to their pension arrangements while continuing to provide an incentive for higher rate tax payers to continue contributing at existing levels.  If there was some money “left over”, this could be used to help deal with smoothing over a change to a RAS approach for all.

Further information

Further information can be found in HM Treasury’s “Pension tax relief administration: Call for Evidence” document at:

Matthew Masters

Actuarial & Investment
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