Spotlight on tax relief and employee pension contributions

We are seeing growing confusion about the methods for giving tax relief via the payroll on employee pension contributions to workplace pension schemes, and applying the wrong method can result in expensive corrections for employers.

When does, confusion arise for giving tax relief?

Typically, the confusion arises where an employer operates a group personal pension plan. Group personal pension plans normally use the ‘relief at source’ method for giving tax relief, meaning that the employer should take the employee pension contribution from the employee’s pay after; first calculating and deducting tax, and without reducing the employee’s earnings subject to Class 1 National Insurance.

The employer pays the net employee pension contribution over to the pension provider, and the provider claims basic rate tax relief on behalf of the employee from HMRC, to increase the overall gross contribution to the pension fund. Employees who are higher or additional rate taxpayers can then consider claiming further tax relief personally via their self-assessment tax returns.

Common mistake

We are seeing increasing examples of employers operating group personal pension plans that should apply the ‘relief at source’ method of tax relief but where employee pension contributions are also reducing employees’ earnings subjected to tax and/or National Insurance via the payroll. This results in tax relief being given twice and underpayments of tax and/or National Insurance under PAYE.

In these cases, the final underpaid liabilities for the employer can be significant, especially where a large number of employees are involved, the error has happened over many years, and HMRC interest charges and penalties are added. The error can also result in the incorrect level of employee pension contributions being paid into the employee’s pension pot.

How to mitigate unexpected liabilities

Employers need to check which method of tax relief applies to their workplace pension scheme and ensure that this method of tax relief is being applied. Warning: where an employer operates more than one pension scheme, different methods of giving tax relief can apply to each scheme.

If an incorrect method of tax relief is being applied via the payroll it is crucial that employers identify this at the earliest opportunity, change the method of tax relief being applied, and consider how to deal with what happened in the past.

Where tax and National Insurance has been underpaid for the past, this must be regularised with HMRC as soon as possible with a voluntary disclosure to HMRC. 

If you have any concerns about the method of tax relief you are applying, or you would like to check that the correct method of tax relief is being applied, please contact us who can help you resolve this.