Your pension provider will apply tax relief in one of two ways:
Relief at source: Also known as ‘net tax basis’. This is usually the default offered by pension providers. Pension contributions are withdrawn from an employee’s salary after tax. The pension provider then claims the tax relief (at 20%) and adds this to the contribution. The advantage is that this applies even to employees who don’t earn enough to pay tax. However, the tax relief takes about six weeks to come through. Additionally, higher rate taxpayers will have to claim their extra tax relief (over 20%) when they submit their tax return.
This kind of tax relief basis would be better for an employer with more employees on low salaries. This is because the tax relief will apply to all employees, even if they don’t earn enough to pay tax.
Net pay: Also known as ‘gross tax basis’. Employee contributions are withdrawn before tax. This means that tax relief is applied straight away because no income tax is paid on money going into the pension. However, employees who don’t earn enough to pay tax will not be able to get tax relief.
This kind of tax relief would be better for an employer with more employees in the higher rate tax bracket. This is because, under a relief at source arrangement, they would have to manually claim their extra tax relief from HMRC. With a net pay arrangement, the automatic tax relief saves them this hassle.
Salary exchange is, in effect, the same as a net pay arrangement, because the pension contribution is a pre-tax deduction from the salary.