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From 6 January 2024, the main rate of class 1 National Insurance contributions (NIC) deducted from employees’ wages is reduced from 12% to 10%. From 6 April 2024, the main rate of self-employed class 4 NIC will reduce from 9% to 8% and class 2 NIC will no longer be due. Those with profits below £6,725 a year can continue to pay class 2 NIC to keep their entitlement to certain state benefits. Our guidance will be updated in full in spring 2024.

Updated on 6 April 2023

Pension tax relief: problems for low earners

Due to the way tax relief is given for employees paying into net pay arrangement pension schemes, some low earners currently do not receive the same tax relief as those who pay into a relief at source pension scheme. Here we look at the problem and also tell you about how the rules are changing in the future to fix it.

The current problem

If you are a low earner (that is, if you earn below or only just above the personal allowance – £12,570 in 2023/24) paying into a pension scheme via your employer, you may wish to check which type of pension scheme you are in. We explain the different types of scheme and the relief that is given in each, on our page How tax relief is given on pension contributions.

If you are in a relief at source arrangement, the pension provider claims 20p tax relief back from HMRC for every 80p of your contribution received – no matter what the level of your earnings. This is subject to the basic rules in relation to who can get tax relief, which we explain under the heading ‘Conditions for relief’ on our page Tax relief on pension contributions.

If you are in a net pay arrangement, you will not currently get any tax relief if your income (before deducting the pension contributions) is below the personal allowance of £12,570. If your income is just over the personal allowance, but your pension contributions bring you below the personal allowance, you will only get partial relief.

Example

Jo earns £950 per month. Jo puts £15 of her pay into her pension scheme every month. The pension scheme operates under net pay arrangements, so her employer deducts the pension contribution before calculating tax. This means Jo’s earnings are taken to be £935 for tax purposes instead of £950. However, as Jo’s earnings fall below the usual monthly threshold for paying income tax (£1,048 for 2023/24), this reduction in taxable income makes no difference and she gets no tax relief on the contributions paid.

If Jo was in a relief at source scheme, her taxable employment income would be £950 a month. She would still not pay any tax, but she would only have to put 80% of £15 (that is, £12) of her pay into her pension pot – the rest is paid into it for her by the government. She is therefore £3 a month, or £36 a year, better off under a relief at source scheme.

The future solution

Following campaigning from LITRG and other organisations, the government agreed to tackle the unfairness faced by low earners in net pay arrangement pension schemes. 

In July 2022, new rules were announced, which will come into effect from the 2024/25 tax year onwards. The rules are broadly as follows:

  • People who pay into net pay arrangements with total employment income (after deducting the pension contributions) of less than the personal allowance will be identified by HMRC following the end of the tax year (so after 5 April 2025 for the 2024/25 tax year).
  • Those identified by HMRC will be entitled to a ‘top up payment’ equal to the tax relief they would have received in their pension pot if they had been under a relief at source scheme. This would be calculated as 20% of the gross pension contribution for the year.
  • There will be a restriction to the top up payment if you are already getting some measure of tax relief on your contribution – so if your income is above the personal allowance before deducting the pension contribution, but is below the personal allowance after the contribution is deducted. This will ensure you do not receive excessive relief via the top up payment.
  • The payment will be automatically calculated and communicated to the individual by HMRC.
  • The individual will then be invited to supply their bank details to HMRC so that the top-up payment can be made. This payment is yours to do what you want with, it does not need to be paid to your pension scheme, although you may wish to do this to boost your pension pot.
  • In future years the payment will then be made automatically.

Example

Continuing from the example of Jo above, let us assume that her pay remains the same in 2024/25 and the personal allowance continues to be £12,570.

Jo’s annual employment income is £11,400 (being £950 x 12 months). Her total net pay pension contributions are £180 (being £15 x 12 months). Jo’s taxable income both before and after deduction of the pension contributions is below the personal allowance for the year, so she will be entitled to a full top up payment from HMRC.

HMRC should write to Jo after 5 April 2025 to let her know she is eligible for a top up payment of £36 (being £180 x 20%). 

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