Tax relief is available on contributions to registered pension schemes up to certain limits. There are two different methods by which employers can effectively give tax relief on employee contributions – net pay arrangements and relief at source.
The names are potentially confusing and HMRC have found some employers are making mistake as a result. In a bid to clear up the confusion, they have published an article explaining the difference in the August 2023 issue of their Employer Bulletin.
To summarise
Under a net pay arrangement, perhaps confusingly, employers deduct pension contributions from the employees gross pay. As a result, tax relief for the contribution is given at the employees marginal rate of tax without the employee needing to take any further action.
By contrast, under relief at source, an amount equal to the pension contribution after the deduction of basic rate tax is deducted from the employees net pay. This means that for a gross contribution of £100, the employer will deduct £80 from the employees net pay. The pension scheme claims back the basic rate of tax on the contribution from HMRC. Despite the name, under this method the employee does not receive full relief at source if they are a higher or additional rate tax payer. Instead they need to claim relief for the excess over the basic rate through their tax return.
The default method is the relief at source method. However, employers can opt to use the net pay scheme when first setting up. Once set up, your scheme cannot be changed.