LITRG urges HMRC to understand scale of pension tax relief errors, ahead of new low-income top up initiative

In a new paper, Workplace Pensions – a hidden problem¹, LITRG highlights that more needs to be done by HMRC to uncover the true scale of errors made by employers when applying tax relief to workplace pension contributions.

LITRG says that understanding the scale of the issue has become more urgent by the introduction of an automatic pensions top-up payment for some low-income earners, an issue LITRG has been at the forefront of campaigning for. This scheme is intended to address the long-standing 'net pay anomaly', under which some lower-income pension savers missed out on pension tax relief². 

Due to the success of pensions auto-enrolment, there are more than 11 million employees in workplace pension schemes. In most cases employees paying into these receive tax relief on their pension contributions equivalent to the highest rate of income tax they pay. The way they receive this tax relief depends on whether these contributions are taken as part of ‘net pay’ or ‘relief at source’ arrangments³.

LITRG’s paper explains that confusion and misunderstanding among some employers over the different types of pension tax relief, means that some employees end up receiving more or less tax relief on their contributions than they are entitled to. The former scenario also leaves employers at risk of compliance action and penalties from HMRC for failing to apply the correct rules. 

LITRG’s paper highlights that one of the main reasons why these errors happen is due to the ‘counterintuitive’ way the reliefs are named in payroll and pensions terminology⁴.

Even where employers spot an issue and are able to fix this with HMRC, this does not update HMRC’s records about what type of pension arrangement an employee belongs to. LITRG says this raises concerns about the quality of the data that HMRC will use to identify those who are due the new top up payment initiative and may lead to incorrect top-up payments being made.

LITRG has also highlighted that recent attempts to uncover any official data or research on the issue or the scale of it have yielded little substantive insight, despite reports from 2018 suggesting that it had led to ‘millions of pounds’ of overpaid tax relief ‘following errors made by tens of thousands of employers’.⁵

To address the problem, LITRG is recommending that HMRC should:

• Replace the confusing payroll/RTI phrase “contributions paid but not under net pay arrangements” with clearer “relief at source” wording to reduce payroll error
• Make it easier for employers to correct historic PAYE errors and ensure that disclosures also correct or flag underlying RTI pension scheme data
• Work with relevant authorities and stakeholders to confirm clear processes for correcting administrative errors and ensure pension providers treat excess contribution refunds consistently.
• Urgently fix an error in its Employer Bulletin article and publish fuller practical guidance for employers on how to correct pension tax relief mistakes
• Use its own RTI and pension scheme data to produce an estimate of how widespread pension tax relief errors are
• Review the quality of the data they hold in their systems, cleansing it where necessary. It should also publish a clear policy on what happens if a top-up has already been paid but later a payroll classification error is discovered.

Notes for editors

1. Workplace pensions – a hidden problem
2. Relief relating to net pay arrangements (GOV.UK, March 2023)
3. The two types of pension schemes are ‘net pay’ and ‘relief at source’. Under a net pay scheme, 100% of an employee’s pension contribution is taken from their salary before tax is deducted. Under the relief at source method, 80% of the contribution is taken from the employee’s post-tax salary. Their pension provider will then claim the extra 20% tax relief from HMRC. While in most cases this means the tax relief will mirror the highest rate of tax, there is an exception for some people with income less than the personal allowance. Non-taxpayers who pay into a relief at source pension scheme are still able to benefit from 20% tax relief on their pension contributions, subject to certain contribution limits. However, non-taxpayers who pay into a net pay pension scheme do not benefit from tax relief. The net pay top-up payment scheme (see footnote 2) is designed to address is disparity.
4. Whereas in payroll terminology ‘net pay’ refers to payments made after tax and ‘relief at source’ to payments made before tax, the opposite is effectively true for pension schemes. This confusion can be exacerbated by some payroll software, including HMRC’s free payroll software used by many small employers, which refer to ‘net pay contributions’ and ‘not net pay contributions’.
5. Errors in pensions tax relief cost millions. Financial Times (14 September 2018).