Pension arrangements can be set up in one of two ways which will have differing outcomes on the way in which tax relief is applied. This can be particularly relevant to part-time and low earners.

Today’s insight explores the difference between the two arrangements, and which providers can support net pay arrangements.

There are two different ways that workplace pension schemes can set up pension arrangements to collect the tax relief that savers benefit from when saving towards a pension. These are net pay and relief at source.

When a member contributes to their workplace pension, a relief at source arrangement means their contributions are taken from their net pay. The workplace pension provider then automatically claims tax relief for the member’s pension from HMRC. They then add the basic tax rate of 20% to the member’s pension contributions.

In simple terms this mean that if a worker had pensionable earnings of £1,000 with a 1% pension contribution, with a relief at source arrangement they would have £8.00 deducted from net pay and paid to the pension provider. The provider would then claim an additional £2.00 from HMRC, so that a total of £10.00 is paid into their pot.

Via this method the member would get the basic 20% rate in tax relief added to their pension savings, even if they do not actually pay tax. It is therefore particularly popular with employers where a large proportion of their workforce earn below the tax threshold and/or work part time.

A net pay arrangement means that a member’s workplace pension contributions are taken from their gross pay before wages are taxed. Therefore, the member only pays tax on what remains of their salary and receives their full tax relief immediately based off their income taxpayer rate.

If a worker had pensionable earnings of £1,000 with a 1% pension contribution, then under a net pay arrangement they would have £10.00 deducted from gross pay and £10.00 would be paid to the pension provider.

By choosing a net pay arrangement, any members who are earning less than £12,500 (in the 2020/21 tax year) would not receive tax relief on their workplace pension as they do not earn enough to pay tax. Therefore, net pay arrangements tend to be more popular with employers who have a high proportion of skilled workforce.

Whilst this may seem like good news for employers with a skilled workforce, our data shows that they may find their workplace pension provider is unable to support this arrangement.

Our data shows that only just over half (55%) of providers can accept member contributions taken via a net pay arrangement.

What arrangement is your workplace pension set up on, and is it the best option for your employees?