When an employee contributes to a pension scheme they get a contribution from the Government in the form of tax relief.
There are two ways that tax relief is applied; at source or through net pay.
Net pay arrangement
With this type of arrangement the pension contribution and the government’s tax contribution is taken from an employee’s pay before tax is deducted. The employee pays tax on what’s left.
If an employee doesn’t pay tax, there won’t be any tax relief.
Relief at source
Pension contributions are taken from employee pay after tax and National Insurance have been deducted. The pension scheme provider then claims the tax back from the government at the basic rate of 20%. This is added to the employee’s pension pot.
The way tax relief is applied is determined by the pension scheme which is why it’s important to choose carefully – the way tax relief is applied makes some schemes more suitable for some employees than other.
How this affects your pension choice
The type of pension scheme you choose will determine which method of tax relief is used – schemes support only one of these methods.
Relief at source
Pros: A scheme operating relief at source will be suitable for staff that don’t pay any tax as they will be able to receive government tax relief on their contributions.
Cons: Employees paying the higher rate of tax will need to fill out a self assessment tax return to claim back their tax relief from HMRC.
Suitable for: Most employers, especially those with lower-paid staff
Pros: Staff paying the higher rate of tax will get their full tax relief
Cons: Lower-paid staff won’t get tax relief on contributions
Suitable for: Employers with staff earning over the personal allowance threshold
For more help with choosing the right scheme read The Pensions Regulator guidance on What to look for in a pension scheme
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