How 1.2million on low incomes will get free cash bank boost worth thousands of pounds for the first time this year
OVER a million workers will soon get a free cash bank boost worth thousands of pounds for the first time this year.
The government is rolling out a new top-up scheme to help those missing out on tax relief on their pension contributions.
Under the existing rules, 1.2million low-income workers miss out on tax relief due to the way their employers handle pension contributions.
Changes coming in for the first time in the current tax year will rectify this, ensuring that everyone receives a government boost when saving for retirement.
With the new system, these low-paid workers will see an average annual increase of £53 in their pension contributions, with 75% of those benefiting being women, according to HMRC estimates.
It means they could be thousands of pounds better off over their working life.
Employers have two methods for administering pension tax relief – “relief at source” (RAS) and “net pay arrangement” (NPA).
When you pay into a pension, you get tax relief on top of the money you put in and your employer contributes.
For instance if you pay £500 in to your workplace pension, £100 of that is tax relief under the RAS method.
But under NPA the person pays the full £500, losing out on tax relief.
That’s because under RAS pension contributions are deducted from your post-tax income, and then the government adds back the tax relief, automatically providing a 20% boost to everyone’s contributions.
Higher and additional rate taxpayers can claim further relief through the government.
However, under the NPA, the contribution is taken before tax is paid.
Helen Morrissey, head of retirement analysis at Hargreaves Lansdown, said: “This can have consequences for some lower earners who receive tax relief on their pension contributions.
“It can have a real impact on people who earn less than the £12,570 personal allowance and don’t pay income tax.”
This system benefits higher earners, who automatically receive relief at 40% or 45% marginal tax rates.
But for those earning below £12,570, this system offers no tax relief on their savings.
However, starting next year, 1.2million lower-paid workers can expect a letter from HMRC offering a tax relief payment directly into their bank accounts.
Steve Webb, partner at pension consultants LCP said: “For over a million people earning below the tax threshold of £12,570, the majority of them women, a quirk of the pension rules means they may currently miss out on tax relief on their pension contributions.
What is pension tax reflief?
ONE of the best features of using a pension to save for retirement is tax relief.
When you pay into your pension, some of the money that would have gone to the government as tax goes towards your pension instead.
This can help reduce the amount of tax you pay and be used to help boost your savings for the future.
Tax relief is given based on the rate of income tax that you pay.
Basic rate taxpayers automatically get 20% tac relief.
High rate taxpayers can claim an additional 20% tax relief through their self-assessment tax return.
Additional Rate Taxpayers can claim an additional 25% tax relief through their self-assessment tax return.
For example, if a basic rate taxpayer wanted to contribute £100 to their pension, they only need to pay £80.
The pension provider would usually claim the remaining £20 from HMRC if you pay in relief at source, which is then added to your pension pot.
“To try to fix this, HMRC will be writing out to them next year for bank details and will then make a payment into their bank account.
“The important thing is to reply to the letter when it comes.
“Otherwise, you may miss out.”
HMRC is now looking at membership information from pension schemes which deliver tax relief through the NPA.
It will then contact these individuals to request their bank details and will deposit the payment directly into their bank accounts rather than into their pension funds.
To benefit from the scheme, workers need to answer “yes” to the following questions at the end of the current tax year:
- Is your taxable income less than £12,570 (after pension contributions)?
- Have you made personal contributions into a workplace pension?
- Does your pension provide tax relief through the “net pay” arrangement?
The payment amount will correspond to the income tax due on the pension contribution.
For instance, if a person has contributed £500 to an occupational pension via the NPA, HMRC will transfer £100 to their bank account.
As a result, the individual will have £500 in their pension at a net cost of £400, the equivalent of somebody paying into a RAS scheme.
Payments will be made after the 2024/25 tax year ends in April 2025.
Affected pension savers will continue to receive annual payments thereafter as long as they continue to earn under the personal allowance.
What are the different types of pensions?
WE round-up the main types of pension and how they differ:
- Personal pension or self-invested personal pension (SIPP) – This is probably the most flexible type of pension as you can choose your own provider and how much you invest.
- Workplace pension – The Government has made it compulsory for employers to automatically enrol you in your workplace pension unless you opt out.
These so-called defined contribution (DC) pensions are usually chosen by your employer and you won’t be able to change it. Minimum contributions are 8%, with employees paying 5% (1% in tax relief) and employers contributing 3%. - Final salary pension – This is also a workplace pension but here, what you get in retirement is decided based on your salary, and you’ll be paid a set amount each year upon retiring. It’s often referred to as a gold-plated pension or a defined benefit (DB) pension. But they’re not typically offered by employers anymore.
- New state pension – This is what the state pays to those who reach state pension age after April 6 2016. The maximum payout is £203.85 a week and you’ll need 35 years of National Insurance contributions to get this. You also need at least ten years’ worth to qualify for anything at all.
- Basic state pension – If you reach the state pension age on or before April 2016, you’ll get the basic state pension. The full amount is £156.20 per week and you’ll need 30 years of National Insurance contributions to get this. If you have the basic state pension you may also get a top-up from what’s known as the additional or second state pension. Those who have built up National Insurance contributions under both the basic and new state pensions will get a combination of both schemes.