Low earners losing out in pensions

A woman reading her fuel bill

Blog written by Christopher Brooks, Senior Policy Manager, Age UK

Since 2012, employees have been automatically enrolled into their employer’s pension scheme, which has meant that nearly 10 million people are now saving for their later life than before. The individual, employer and government all make a contribution, and this co-funding arrangement will in most cases benefit the employee, who can still opt out of the scheme if they wish.

At present, the saving contribution is 5 per cent of someone’s relevant salary (earnings between lower and upper earnings limits), but this will rise to 8 per cent in April 2019.

Auto-enrolment’s success is good news – in years to come it will help many older people have a higher income that they would have otherwise enjoyed, and Age UK continues to support it.

‘Net pay’ can mean ‘not paid’

But one anomaly in how the government contributions are administered has become even more significant with the increasing numbers of lower-income pension savers, and according to the Low Incomes Tax Reform Group this is leaving 1.2 million savers worse off. All of these people are lower earners, who find that they are paying themselves for the Government contribution – hugely unfair and in breach of the promise for the Government to help people save.

The explanation is fairly technical, but it goes something like this:

1) Employers use two types of payroll system for making their pension contributions, known as ‘Net Pay Arrangements’ and ‘Relief at Source’ (RAS). Under RAS arrangements, the Government contribution is automatically claimed on your behalf, by the pension company and added to your pension plan and everyone gets this regardless of their salary.

2) Under Net Pay Arrangements, the tax relief that pension saving attracts is administered by the employer, who takes the pension payments from your gross (total) pay, reducing your taxable income and therefore the tax you pay. But this means that if you don’t pay income tax, you don’t get tax relief. In effect, you yourself would be paying the Government’s contribution – nice for the Treasury, not so good for you.

This problem only affects savers in ‘Net Pay Arrangements’ who earn under the income tax personal allowance (currently £11,850) – i.e. they don’t pay income tax.

At the moment it means low earners are missing out on £35 a year, but increases in pension contribution rates and the income tax personal allowance will mean it rises to £58 in April 2019. For someone on a low income, this can be a significant amount of money.

Putting an end to it

Age UK has recently joined forces with other organisations and senior figures from the pensions industry to campaign against this. The open letter sent to the Chancellor, Philip Hammond MP, earlier this month received widespread media coverage, and there are already signs that the Treasury is looking to resolve the issue.

Alongside the other organisations involved, we will remain active on this until we get a satisfactory resolution.

Hopefully, we can help get some fairness for lower earners, enable them to stay in the pensions system, and enjoy the fruits of their savings when they reach retirement.

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