Millions hit by shocking pension scandal: will you lose out?

Millions of part-time workers are being denied their pension tax relief due to a bizarre loophole.

More than two million part-time UK workers are being refused valuable tax relief on their workplace pension contributions, thanks to an absurd loophole that the Government has failed to close.

According to new research from financial advisers Chase de Vere, up to 1.5 million low-paid private-sector employees and a further 800,000 part-timers in the public sector are affected. Together, they lose out on a total of £186 million each year in unpaid tax relief on pension contributions to their occupational schemes.

Shockingly, the Government is fully aware of this issue, yet HM Treasury continues to allow workers to save into these schemes, despite knowing that these workers will not get the tax relief they are due.

Losing out on £186 million a year

This problem arises because there are currently two very different ways to administer pension tax relief for workplace pension plans.

With the first arrangement, known as 'relief at source' schemes, all scheme members – regardless of their earnings – receive tax relief through a top-up from the state that is paid directly into their pension pots after pension contributions have been taken from their gross pay.

This tax relief is automatically credited to their pensions, even for workers earning less than the Income Tax threshold of £10,600.

It is with the second arrangement, known as 'net pay' schemes, where the problem arises. Net-pay schemes allow taxpayers (those earning over £10,600 a year) and higher earners to be credited with tax relief. However, there is no mechanism in net-pay arrangements to deliver 20% tax relief to non-taxpayers – even though non-taxpayers are entitled to this basic tax relief.

In other words, low-paid and part-time workers in 'relief at source' arrangements get the tax relief they are owed, while those in net-pay schemes do not.

Frighteningly, almost all low-paid workers are unaware of this loophole, which is denying them pension cash to which they are entitled.

What can you do?

The very first thing you should do is ask your personnel or HR department whether your workplace pension operates on a 'relief at source' or a 'net pay' arrangement. If your occupational pension offers relief at source, then you have nothing to worry about.

However, if yours is a net-pay scheme and you earn less than the personal tax allowance, then you have a problem, because you are not getting the tax relief you are due. This could mean losing out on around £125 a year over £10 a month in tax relief. Over the course of a working lifetime, this loss could reduce the value of your pension pot by thousands, leaving you considerably poorer in retirement.

Alas, there is absolutely no mechanism (not even through yearly self-assessment tax returns) for low-paid workers in net-pay schemes to reclaim this lost tax relief. In short, the Government is knowingly encouraging low-paid workers to save into pension schemes that will not deliver the tax relief they are due, which is nothing short of scandalous.

Workplace pension provider NOW: Pensions has launched a campaign to push the chancellor, George Osborne, to close this loophole and pay tax relief to every worker entitled to it.

A growing headache for the Government

One big headache for HM Treasury is that this problem is set to grow, thanks to two trends. First, as the Income Tax threshold rises from the current £10,600 a year to £12,500 a year by 2020, ever-more low-paid workers are going to be caught in this tax-relief trap.

Second, in the words of Hugh Nolan, chief actuary at JLT Employee Benefits, "The huge numbers being automatically enrolled on lower salaries is exacerbating the issue." As more and more workers are employed on minimum-wage or zero-hours contracts, increasingly more employees will lose out on tax relief.

The National Association of Pension Funds, the trade body for workplace pensions, warned: "The current anomaly between net-pay and 'relief at source' is a very real – although very recent – problem for both savers and schemes. We have asked the Government to conduct a thorough review of how this issue can best be resolved and avoided in the future."

Sean McSweeney at Chase de Vere adds, "We suspect this will come as a huge shock, not only to part-time employees, but many employers, too. The lesson is clear: for employees, do not assume you will automatically get tax relief if you pay into a pension."

The next pensions mis-selling scandal?

Another big worry for workers and the Government is the possibility of mis-selling claims from low-paid workers who were encouraged to enrol in net-pay schemes, only to later discover that they do not get the tax relief automatically given to higher-paid employees. 

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