Pension tax loophole could cost Treasury £20bn

Early access pension rules may revolutionise the way the over 50s are paid salaries as the new rules leave a tax avoidance loophole around a third of employers intend to exploit to save money.

The government may have grossly underestimated the amount of national insurance companies and employees may save by diverting some of their salaries into pensions.

The Treasury could lose up to £20 billion a year, according to research by financial firm Jelf Employee Benefits.

The loophole works by employers making pension contributions rather than paying salaries.

Payroll rules dictate that workers and employers must pay national insurance contributions (NIC) on salary – with workers generally paying 12% of their salary and employers 13.8% as NIC.

Payroll revolution

However, if the cash is paid directly into a pension, no NIC is due and pension contribution relief immediately increases the amount by 20% for a basic rate taxpayer.

Once aged 55, the worker can draw the money from the pension with the first 25% tax-free and income tax paid on the balance. No NIC is paid on pension benefits.

The over 50s can pay up to £40,000 a year in pension contributions, while those over 55 who have already drawn down on their pension are limited to adding an extra £10,000 a year to their pension funds.

The study asked 200 employers about their plans for paying salary as pension contributions.

More than a third agreed they would allow workers over 55 to take a portion of the salary as pension contributions. Another 15% stated they would consider cases if asked by their employers and only 6% said they would not take part in such a scheme.

Tax savings

For an employee on the average wage of £29,000 a year paid monthly, diverting cash into a pension rather than into salary would give NIC savings of £241.91 to the employer and £210.36 to the employee each month.

How much NIC could you save – try the HM Revenue & Customs (HMRC) calculator

Jelf Employee Benefits head of benefits strategy Steve Herbert said: “The response to the survey suggests the government may well have under estimated just how many companies and workers will go down this avenue to boost pensions and save money.

“The government may decide to tighten early access pension rules to try to stop this tax avoidance strategy.”

The new rules start from April 5, 2015.