From Ros Altmann:economist and pensions,
    investment and retirement policy expert

  • pensionsandsavings.com

    Helping low earners’ pensions – Glad to see Government’s Call for Evidence

    Helping low earners’ pensions – Glad to see Government’s Call for Evidence

    • Government calls for evidence on addressing scandal of lowest earners paying 25% extra for their pensions.
    •  Over one million low-paid women are unknowingly auto-enrolled into employer schemes which leave them with lower take-home pay.
    • Who is looking after these lowest earners who surely need every penny of their pay and their pensions and cannot protect themselves against the income loss. 
    • Short-term fixes could include requiring employers to use suitable schemes for low earners or for schemes and employers to ensure they don’t lose out.  

     The Government has today launched its promised Call for Evidence about a significant problem in auto-enrolment pensions, which has been swept under the carpet for years. It affects the very lowest earners (those earning less than the personal tax threshold) for whom saving in a pension is usually the biggest sacrifice and who usually need as much help as possible to achieve a good pension. I congratulate Ministers for honouring their Manifesto commitment and hope there will finally be a resolution to this significant social injustice. https://www.gov.uk/government/consultations/pensions-tax-relief-administration-call-for-evidence

    Two different ways to administer workplace pension schemes: This problem stems from the two different systems used by pension schemes for administering pensions tax relief. One is called ‘Net Pay’, which takes contributions from pre-tax income directly using the employer payroll system and does not need to claim tax relief from HMRC directly. The full contribution and tax relief are invested immediately after deducted from workers’ pay. The second system is called ‘Relief at Source’. This administrative arrangement is an after-tax method which takes a pension contribution from taxed income and then the scheme automatically claims and receives basic rate tax relief from HMRC. Higher rate taxpayers have to claim their higher rate relief themselves in Net Pay schemes, but the lowest earners receive the tax incentive they are entitled to for pension saving, which amounts to 25% added to their own contribution. Take-home pay for low earners in Net Pay schemes is, therefore, lower than if their employer had used Relief at Source schemes.

    Over 1.5million low earners losing out: The Treasury says that these two systems ‘may produce different outcomes in limited circumstances’. But these ‘limited circumstances’ cover at least 1.5million low-paid workers (three-quarters of whom are women) who do not get the Government incentive top-up to their pension. They end up paying 25% more than they would do if their employer used a different scheme. This issue has not received the urgent attention it deserves and both Government and Regulators have failed to provide a resolution. The Call for Evidence is, therefore, welcome. An industry working party with the Low Income Tax Reform Group has been meeting with Treasury and officials and it is good that more people are recognising the injustice and pressing for reform.

     Success of auto-enrolment blighted for over a million women: Forcing the lowest earners – mostly women – to pay so much extra for their pensions seems indefensible. They need as much help as they can to build up decent pensions, yet they are powerless to protect their interests. Their employer chooses the scheme, they are usually unaware of this problem and, even if they did know, they cannot reclaim the money from HMRC.

     Lowest earners living on less money than if their employer used another pension scheme – workers on £11,000 a year take-home pay reduced from £10,040 to £9,800: The Call for Evidence gives clear examples of the difference to these low earners. Let’s use the Government’s example of two workers earning £11,000 a year (many care workers are on this type of income).  The document shows that one worker with a £100 a month pension contribution to a Relief at Source pension scheme would have £1200 in their pension after a year. But 25% of this would have come from the tax relief. So (ignoring other deductions from their salary) their take home pay would be £10,040. But another worker also on £11,000 a year salary, who also puts £100 a month into their pension, would not get any tax relief on their pension contributions, so they would have to pay the full £1200 themselves and their take home pay would be just £9800. Therefore, they receive £5 a week less to live on, just because their employer pension scheme operated on a different administration basis.


    Government example: Two workers earning £11,000 a year

    Type of scheme Monthly pension deduction Tax relief added to pension Amount in pension at year end Take home pay (ignoring other deductions)
    Relief at Source £80 £20 £1,200 £10,040
    Net Pay £100 0 £1,200 £9,800


    Government talks of ‘appropriate balance’ between fairness for low earners and simplicity for employers or pension schemes: The Government says that it has not found a reasonable way to address this injustice. It talks of a balance between consistency of outcomes for individuals with similar circumstances (i.e. treating people fairly) and simplicity, deliverability and proportionality (i.e. not burdening employers, HMRC or pension providers). Yes, a Relief at Source or Net Pay arrangement is suitable for around 80% of taxpayers who are on basic rate tax. However, I believe the programme of auto-enrolment is most particularly important for the lower earners, who need most help to build up decent pensions.   The amount of money going into the pension schemes is not lower, the fees the industry earns are not impacted and it is only the low earners themselves who are losing out.

    Low earners’ interests do not seem to be sufficiently of concern: Why is Government not yet convinced that employers should be concerned about this. It asks ‘Is the method of tax relief a scheme operates a relevant factor in the employer’s decision e.g. directly  when considering employees’ financial positions, or indirectly e.g. through an impact on provider fees’. This question suggests the extra burdens on low earners can be justified and seems to ignore the scale of the additional costs being imposed on the lowest earners. These extra costs are way beyond the small differences in fee levels charged by different schemes.

    Low-earners paying 33 times the maximum charge cap on their pension: There is a maximum cap of 0.75% a year on the fees in auto-enrolment default funds, yet more than a million women have been automatically enrolled in a scheme where they are pay 33 times this supposedly maximum fee, on top of the fund fees themselves. This additional cost is not explained to them, and most small employers know little about pensions and are unaware of this too.

    Government suggests four potential ways forward: The Call for Evidence offers four potential ways forward.

    1. Changing HMRC systems so that the extra money paid by low earners in Net Pay schemes can be reimbursed to them. This would involve additional administration for HMRC, but it would be a permanent resolution that could also deal with differential tax rates in devolved nations. It might also need the low earners to claim their bonus. This is the method so far favoured by the Industry Working Group which I have worked with.
    2. HMRC should claw back the tax relief given to low earners in Relief at Source schemes! That this is even suggested is something which I find astonishing. If these non-taxpayers do not receive any Government incentive for their pension saving, firstly it would mean fewer would receive a private pension in retirement and more would end up in poverty; secondly it would mean people could have received no incentive to save in their pension but would still face tax in retirement on their pension income.
    3. Employers should use more than one pension scheme – this is my favoured solution of those suggested: This would mean low earners receive the extra money they are entitled to in a Relief at Source scheme, while higher earners could be in a Net Pay scheme that does not require them to reclaim the higher rate tax relief. The Government suggests this would be ‘complicated’ for employers, however it seems to me that this solution would be the fairest short-term fix of those it has proposed. Employers should ensure that, if they have any workers on their payroll who might earn less than the personal tax threshold, they only enrol them into a Relief at Source scheme. If the employer does not want to select a scheme, then NEST could be used as a default position. The employer could also, perhaps decide to use a RAS scheme for the majority of their workforce, with only higher rate taxpayers being put into a Net Pay scheme. This would help ensure the top earners don’t have to reclaim the higher rate tax relief that some people fail to claim.
    4. Force all workplace DC schemes to switch to Relief at Source: This would ensure that all the lowest earners receive the tax relief they are due and that their take-home pay would not be reduced as it would be in a Net Pay scheme. This seems like a draconian solution and would be burdensome for many of the new MasterTrusts. The majority of workplace pension MasterTrusts operate on a Net Pay basis and are, therefore, potentially unsuitable for low earners.

    Resolution is urgently needed: These proposals are all potential ways of addressing this issue but the main point is that, while the issue remains unresolved, the lowest earners are having to live on less money than they would have if their employer had auto-enrolled them into a different type of pension. I believe employers should be told that a Net Pay scheme is not suitable for low earners. Employers are required to choose schemes that are suitable for their staff and are encouraged to look at the fees charged by the chosen scheme. How can it be right that employers have not been required to recognise this problem and look after their low earners in this regard?

    My alternative recommendations: As a near-term resolution, pending any major changes to pensions tax relief administration, there are changes which can be suggested that would ensure the low earners, who are currently unknowingly paying 25% more for their pension than they would otherwise need to, do not suffer a reduction in their take-home pay: 

    1. Place a duty on employers to ensure the pension scheme they use does not disadvantage low earners. Currently, the MasterTrust assurance system and requirements of advisers do not have to take this issue into account. I think it would be reasonable to require employers and their advisers to ensure their low earners are not disadvantaged by the choice of scheme.
    2. Ask employers to pay the 25% equivalent of basic rate tax relief.  If they wish to continue using a Net Pay scheme for all staff and they do have low earners, employers could contribute more for their low earners so take-home pay is unaffected.
    3. Alternatively, ask pension schemes to make up the shortfalls. Net Pay schemes which take in members who earn below the personal tax threshold to reimburse these members for the additional 25% they have had to pay

     One has to ask who is looking after these low earners’ interests?: The law is unclear on this issue and pension providers, Regulators and advisers have seemingly overlooked the problem, each suggesting that someone else should resolve it. In the end, however, it is the workers who are losing out, not the other parties. It is the lowest paid who bear the cost themselves.

    One thought on “Helping low earners’ pensions – Glad to see Government’s Call for Evidence

    1. Hugely important issue to addrezs. However, low earners need even more help with narrowing the salary gap. Every time there is a (say) 2% inrease in wages, low earners hardly notice the difference, whereas high earners barely need it, and can spend it on extras that low earners never dream about. This is outrageous.

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