If your employer offers a workplace pension, it has a choice of two tax-relief arrangements that apply to employee contributions.

There is a small, but very significant difference, in the two options which means that although you’ll be contributing the exact same amount of money into your pension, the amount of take-home pay will vary. As a result a person in one scheme may have less money each month than someone else, whose employer comes under the alternative tax-relief arrangement.

The issue particularly affects part-time workers and low earners who earn under £11,500.

The two tax-relief arrangements explained

An employer has a choice of two tax-relief arrangements that apply to employees’ contributions:

• Net pay arrangement: this is where the employer takes an employee’s pension contribution from their pay before it’s taxed (gross) so employees get full tax relief unless they don’t pay tax.
• Relief at source: this is where the employer takes an employee’s pension contributions after taking tax from pay. The pension provider then adds 20% tax relief to pension pots.

Why are part-timers and low-earners impacted?

It’s almost a mis-alignment or gap between two different thresholds set by the government.

The first relates to the pension auto-enrolment scheme. In order for employees to be eligible, they need to earn at least £10,000 a year from a single job.

And as part of the personal allowance – the amount of income you can earn before you start paying tax – the figure stands at £11,500 for the 2017/18 tax year.

As a result, anyone earning between £10,000 and £11,500 is affected.

Under the net pay arrangement, lower paid workers don’t qualify for tax relief as the earnings are below the annual income tax personal allowance.

But under the relief at source arrangement, while the same contribution amount is taken, the other is taken less the tax relief which is reclaimed by the pension scheme.

Keith Gorbutt, technical manager at Dentons Pensions, says while employees under either arrangement fall below the income tax threshold of £11,500, the net pay arrangement “is a very unfair way of deducting pension contribution for the low earner and part-time worker”.

Gorbutt gives the following calculations to explain the difference:

Under a net pay arrangement, an employee earning £10,400 (£200 a week), paying a 1% pension contribution will have the full £2 a week deducted from their pay which is paid into their pension. They can’t claim any money back from HM Revenue & Customs (HMRC) and so will have less take home pay as a result.

Under the relief at source arrangement, an employee earning £10,400 (£200 a week), would have £1.60 a week deducted from their pay and paid into their pension. The scheme would then claim the 40p from HMRC, so that a total of £2 a week is paid into the pension.

For someone earning £11,000 (£211 a week) paying a 1% contribution, under a net pay arrangement they would have £2.11 a week deducted from their pay. Again, no money can be reclaimed from HMRC. But under the relief at source arrangement, the employee would only need to contribute £1.69 a week while the scheme would claim 42p from HMRC, so a total of £2.11 per week is paid into the pension.

Looking at the annual take home pay based on an £11,000 salary, under net pay an employee would have take home pay of £10,890.28, while under relief at source they would be left with a higher £10,912.12.

It’s important to speak to your employer

Auto-enrolment is entering the last phase, where the smallest and newest employers will need to offer a workplace pension scheme.

Gorbutt says it’s down to employers discretion as to how the pension scheme payments are made, which is why the employer should seek financial advice when setting up the scheme which is to the benefit of all employees.

He says: “For the very low paid part-time employee the most tax advantageous form of payment contribution would be relief at source, as a net pay arrangement would almost certainly affect their take home pay of the low paid.

“The employer when setting up the scheme with advisers should look at the employee demographic and ensure that the method of paying pension contributions doesn’t impact low paid workers’ take home pay.”