HMRC is currently writing to over a million people offering them tax relief. While the phrase “make a pension contribution and you get tax relief” sounds straightforward, the underlying mechanics are a bit more complex. Receiving an unexpected letter from HMRC offering to pay you money often triggers alarm bells as a potential scam, but in this instance, the giveaway is completely genuine.
Understanding How Pension Tax Relief Works
There are two primary methods through which tax relief on pension contributions is administered. The type of scheme you are enrolled in dictates how and when you receive this benefit.
Pension Relief at Source (PRAS)
This method typically applies to personal pensions and select occupational pension schemes, including the National Employment Savings Trust (NEST). Under PRAS, your contributions are deducted from your after-tax pay. HMRC then pays the basic rate tax relief directly to your pension provider.
For example, if you make an £80 contribution, HMRC adds a £20 top-up, bringing your total contribution to £100. This £20 addition applies even if your income is so low that you are a non-taxpayer. However, if you are a higher or additional rate taxpayer, you must actively claim the extra relief from HMRC—a step that is frequently forgotten.
Net Pay Arrangement (NPA)
Most occupational schemes operate under a Net Pay Arrangement. Here, your pension contributions are deducted from your pre-tax pay. For a basic rate taxpayer, a £100 total contribution automatically saves £20 in tax. Higher and additional rate taxpayers (including those paying assorted Scottish rates) also receive their appropriate relief automatically, completely removing the need to claim.
However, there is a catch: non-taxpayers enrolled in an NPA scheme miss out entirely on the 20% relief they would have otherwise received under the PRAS method.
The Anomaly for Low Earners and Part-Timers
For a long time, the missing basic rate relief for non-taxpayers under NPA was viewed as a legislative anomaly. Successive governments overlooked the issue until the introduction of automatic enrolment in workplace pensions significantly increased the number of people—predominantly part-time workers—who were losing out.
Since 2014/15, automatic enrolment has operated with an earnings threshold frozen at £10,000 a year. Initially, this figure aligned with the income tax personal allowance. However, while the personal allowance eventually rose to £12,570 (where it is now frozen), the auto-enrolment threshold remained at £10,000, creating a £2,570 gap where workers are auto-enrolled but do not earn enough to pay income tax.
HMRC’s Solution: Claiming Your 2024/25 Top-Up
To rectify this imbalance, the Chancellor announced in the Autumn Budget 2021 that legislation would be introduced to ensure all pension contributions effectively receive basic rate tax relief.
The eventual solution shifted the responsibility to HMRC, requiring them to pay the relief directly to eligible non-taxpayers, starting with contributions made in the 2024/25 tax year. HMRC has now begun contacting approximately one million eligible individuals to prompt them to claim their 2024/25 relief, which is estimated to be worth an average of £53 per person.
Speak to Chartwell Wealth Management
Navigating the complexities of pension contributions, tax allowances, and HMRC top-ups can be overwhelming, but you do not have to manage it alone. At Chartwell Wealth Management, our highly qualified financial planners are dedicated to helping you optimise your retirement strategy and ensure your investments are working as tax-efficiently as possible. Whether you need clarification on your current workplace pension or comprehensive retirement planning, we are here to provide expert, personalised advice. Contact Chartwell Wealth Management today to secure your financial future.
Important Information:
Tax treatment varies according to individual circumstances and is subject to change.
The Financial Conduct Authority does not regulate tax advice.
