By Fiona Tait, Technical Director, Intelligent Pensions
The result, for a small but politically key group, is quite simply that some people get more money than others as the result of a decision over which they have no control.
HMT’s paper points out, quite correctly, that for the majority of members it makes no difference whether the scheme chooses to operate the default RAS solution or the administratively easier net pay option. 83% of UK taxpayers pay only basic rate tax and have no skin in the game beyond a wish to see fair play. Higher and additional rate taxpayers are also unaffected and probably just want to keep quiet in case of any wider changes to tax relief.
The problem is that the 1.5m low earners in net pay schemes get precisely the tax relief they are entitled to whereas the 1.3m in RAS schemes, arguably, get more than they should because the scheme is entitled to claim basic rate relief even though the member hasn’t actually paid it.
4 solutions
The consultation paper outlines 4 possible solutions:
1. Top up contributions from those in net pay schemes to match the tax relief given to those in RAS arrangements.
2. Apply a tax penalty to RAS members at the end of the tax year to offset any basic rate tax relief which the member is not entitled to.
3. Requiring employers to operate a separate scheme for low earners
4. Requiring all workplace schemes to operate on a RAS basis.
Net pay bonus
This is the so-called ‘P800 solution’ favoured by the Pensions and Lifetime Savings Association (PLSA) whereby the bonus would be claimed at the end of the tax year in the same way as any overpayment of tax. This method has the advantage that the bonuses would be based on up-to-date Real Time Information (RTI) and should be accurate. HMT have however pointed out a number of practical difficulties, most of which noticeably apply to their own systems. Although none of them seem to be unsurmountable it seems likely they would require considerable persuasion to follow this route.
More justifiable is the objection that net pay members would have to wait several months for the bonus while RAS members obtain the same amount up front.
Tax penalty
While HMT are not normally reluctant to levy additional taxes, it seems in this case that the work required outweighs the advantage of additional revenue. HMRC would have to undertake a significant reconciliation process each year, which would be complicated by the fact that many low earners have multiple employments.
HMT also, somewhat virtuously, points out that this method “would mean taking money from some of those on lower incomes who are saving for retirement” who are not just the underpaid but also the chronically under-pensioned.
Separate schemes for low earners
The idea is that employers would be required to run 2 separate pensions schemes and be willing and able to switch members between them as and when their earnings exceed, or fall below, the Personal Allowance. The advantage to government is that no new legislation would be required but the burden on employers would be considerable.
Requiring all schemes to operate RAS
This would appear to be HMT’s favoured solution and it does have the considerable advantage of consistency. This whole issue has arisen because workplace schemes have a choice which DB schemes and personal pensions do not and this is the only solution which would resolve all of the current inequalities of rate and timing. Unfortunately, it seems that RAS is less popular with employers than net pay, the latter of which requires less paperwork and ensures that members receive the correct marginal rate of tax relief in one go without multiple adjustments later on. Following the devolution of tax powers this is particularly helpful for employers with workers living across the Scottish (and potentially Welsh) borders.
It also seems highly unlikely that final salary schemes would be able to switch to a RAS basis, creating one more inequality to the DB-DC playing field.
In summary
If anything, this paper seems to underline the fact that there are no easy answers. Any solution will require significant changes to systems and processes, it will be interesting to see whether HMRC will be prepared to take on the hard graft or whether employers will once again have to bear the burden.
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