How Tax Relief and the Earnings Contribution basis affect pension contributions

If you wish to check that an employee is having the correct pension deduction made from their pay, it is important that you understand how tax relief and the earnings contribution basis affects these deductions.

Tax relief:

• When using a Relief at Source (RAS) pension scheme (such as NEST), the pension scheme administrator claims basic rate tax relief from HMRC and adds it to the pension pot of the employee. For example, if a member wishes to make a £100 contribution to their pension then they’ll only need to have £80 deducted from their pay and added to their pension scheme. The scheme administrator then reclaims £20 from HMRC making up the pension pot to £100.
If you set the employee pension deduction to 5% in Payroll Manager, using a RAS scheme, the software will calculate a 4% deduction and the pension company will reclaim the remaining1% . Contributions made to a RAS scheme do not affect the amount of income tax calculated for the employee as this is based on the whole amount of taxable pay, before the pension deduction is taken. NEST Pensions (and some other schemes) use the Relief at Source method.
• When using the Net Pay Arrangement (NPA), the pension contribution is taken before the calculation of tax. For example, if a member wishes to make a £100 contribution into their pension scheme then a £100 deduction is made from their pay. Tax is then calculated on the remaining amount, meaning contributions made to a NPA scheme do affect (i.e. reduce) the amount of income tax calculated for an employee.

How the Earnings basis for contributions affects the deduction amounts:

Different pension schemes allow for different earnings basis on which % contributions are to be calculated (the basis used is agreed between the employer and the pension provider).

• • If using all pensionable pay as the earnings basis, then contributions are calculated from the first pound of earnings e.g. If an employee is paid £1000 month and contributes 5% to the pension using this earnings basis, then the deduction is 5% of £1000.
  • If using banded qualifying earnings only as the earnings basis, then contributions are calculated on the earnings falling between the lower and upper thresholds for qualifying earnings (The bands for 2023-24 and for 2024-25 are £120 - £967 for weekly paid employees and £520 - £4189 for monthly paid employees. ).  e.g. If an employee is paid £1000 month and contributes 5% to the pension using this earnings basis, then the deduction is 5% of £480 (i.e. 5% of (£1000 -£520)).

It is important that you have the correct tax relief method and earnings basis set up in Payroll Manager in order for these calculations to be correct (click ‘Pensions‘ then ‘Pension Scheme Details’ from the main menu in Payroll Manager to view these settings.)