The 'net pay anomaly' and workplace pension schemes

The Government's solution for the 'Net Pay Anomaly' - "Don't ring us, we'll ring you!"

If there's one tin can that has been kicked down the road remorselessly by HM Treasury over the last few years, it has to be the one with the 'net pay anomaly' label stuck on the front of it.

"What's the net pay anomaly?" I hear you cry.

It potentially affects those individuals who receive annual earnings of at least an amount that qualifies them to be auto-enrolled into a workplace pension scheme (£6,240 for the 2021/22 tax year), but who receive no more than the prevailing income tax personal allowance (£12,570 for 2021/22).

There are two main types of workplace pension scheme, which are used for auto-enrolment.

One is called a ‘net pay arrangement’ (NPA), and the other is called a ‘relief at source’ (RAS) scheme.

The ‘anomaly’ arises because of the way that individuals receive income tax relief when saving some of their earnings into one of these two types of workplace pension scheme.

"Individuals with similar earnings receive different levels of tax relief, depending on what type of pension scheme they have been auto-enrolled into"

For an NPA, an individual (theoretically) receives tax relief when pension contributions are taken out of their pay by their employer before income tax is calculated on the balance. 

For an RAS scheme, however, the administrators claim tax relief at the relevant basic rate of 20% from HM Revenue & Customs (HMRC), because individual members make pension contributions out of their earnings after income tax has been calculated. 

This means that employees contributing to RAS schemes receive an HMRC ‘top-up’ of 20% on their pension contributions, even if they pay no - or a lower rate of - income tax. 

In contrast, employees contributing to an NPA receive tax relief at their marginal rate, which for those with taxable earnings at or below the personal allowance, is 0%. 

This, therefore, creates an anomaly in which individuals with similar earnings receive different levels of tax relief, depending on what type of pension scheme they have been auto-enrolled into.

Time for a change

The government recognised this inequity for years, and yet all that could be heard was the sound of a hollow metal object bouncing down a long concrete lane. In 2020, however, things finally started to change. 

HM Treasury launched a Call for Evidence, which set out three reform principles required for any changes to be made to the prevailing situation; namely simplicity, deliverability and proportionality. Essentially, the government was asking the financial services industry to come up with a solution to the ‘net pay anomaly’ that would satisfy these three reform principles.

Then, in the autumn Budget on 27 October 2021, the government announced that it would introduce a system to make top-up payments to affected individuals saving into NPA schemes, in respect of their pension contributions.

To accompany the announcement, John Glen MP, Minister of State (Economic Secretary), said: “We have identified a solution…for all lower earning pension savers. Individuals making pension contributions to net pay schemes…will be eligible to claim a top-up. Up to 1.2 million individuals, 75% of whom are women, could benefit by an average of £53 a year. As a result of this change, all lower earning pension savers should receive similar outcomes, regardless of how their pension scheme is being administered for tax purposes.”

So far, so good. 

Now, how quickly is this solution going to be introduced? Indeed, will it be made retrospective from the tax year in which the individual was first auto-enrolled into the NPA scheme?

Sadly not.

That battered old tin can has been given yet another hefty kick, and the solution will only begin from the 2024/25 tax year onwards. 

As these top-ups will be paid after the end of the relevant tax year, this means that the first payments will not be made to affected individuals until the 2025/26 tax year. 

Why the delay? 

The written HM Treasury response to the Call for Evidence states that, “…the time lag between announcement and implementation of this system is due to the complex nature of the IT systems changes required, as well as other ongoing HMRC delivery programmes.” 

Aside from the timescale to commencement, a more worrying feature is the way in which the top-up payments will be made. 

"My immediate concern was that scammers would be rubbing their hands in glee at this news"

I initially thought that HMRC would pay the top-ups to the NPA scheme administrator, for allocation between the affected members, in the same way as they currently do for RAS schemes.

But I was wrong. 

Once HMRC has calculated the top-up payment, it will contact the affected individuals and ask them for details so that they can make the payment to the individual directly. 

My immediate concern was that scammers would be rubbing their hands in glee at this news. You can imagine the telephone conversation that could take place:

“Hello – is that Mrs Miggins? It’s HMRC here, and I’ve got some great news for you! Because of the type of pension scheme that you’re in, you’re now entitled to a payment of £53, for you to spend on whatever you like! 

I’m ready to pay this money to you now. All I need is your full name, your date of birth, and your bank account details - and then I’ll do the rest.”

It’s worrying, because you can imagine a call like that happening so easily. And it is likely that a majority of these individuals will have had little, if any, experience of dealing with HMRC previously, and so will not be on their guard to watch out for scams, as those who file self-assessment tax returns every year.

Therefore, it is vital that, while HMRC order extra string, sticky-tape and rubber-bands to reinforce their IT systems, a robust communication process is put in place to ensure that those involuntarily affected by the ‘net pay anomaly’ do not become innocent victims of an industrial-scale scam.

The government have finally reached a solution to the ‘net pay anomaly’.

Most importantly of all, the solution needs to be secure, watertight, and scam-proof.

And does what it says on the tin.