How it works
Under a net pay arrangement:
- Your gross pay is reduced by the pension contribution before Income Tax is calculated
- National Insurance is still calculated on your full gross pay (before the deduction)
- You get full Income Tax relief at your marginal rate automatically — no need for higher-rate claims via Self Assessment
For a higher-rate taxpayer earning £55,000 contributing 5%:
- Gross pay: £55,000
- Pension contribution: £2,750
- Taxable pay (for Income Tax): £52,250
- Pay used for NI: £55,000
The full 40% Income Tax relief on the £2,750 contribution is automatic. Compare to relief at source, where the same person would only get 20% automatically and need to claim the extra 20% via Self Assessment.
The confusing name
"Net pay arrangement" is one of the most confusingly named items in UK payroll terminology. The "net pay" in the name refers to the salary that's left after the pension contribution — i.e., the contribution is taken from gross to leave a net figure before tax. It has nothing to do with your overall net (take-home) pay.
To distinguish:
- Net pay arrangement — a pension contribution mechanism (this term)
- Net pay — your take-home pay after all deductions (different concept)
Who uses net pay arrangements
Common in:
- Defined benefit pension schemes (the traditional "final salary" or "career average" schemes — common in the public sector, NHS, teachers, civil service)
- Older defined contribution workplace schemes that pre-date the surge of relief-at-source providers
- Some employer-sponsored AVC arrangements
Less common in:
- Personal pensions and SIPPs — almost all use relief at source
- Newer workplace pensions (Nest, People's Pension, etc.) — typically use relief at source
Net pay vs relief at source — which is better
For Income Tax purposes the end position is identical: you get full relief at your marginal rate either way. The differences are:
- For basic-rate taxpayers: identical Income Tax outcome; both methods skip the basic-rate (20%) tax
- For higher-rate taxpayers: net pay is more efficient because the full 40% relief is automatic; relief at source requires the extra Self Assessment step
- For low earners below the personal allowance (under £12,570): net pay arrangements have historically given less than relief at source, because relief at source claims the 20% basic-rate relief regardless of whether you actually pay tax. This was addressed by the 2022 reform — HMRC now tops up affected net-pay scheme members.
National Insurance differs between methods: net pay arrangements still apply NI to the contributed amount, while salary sacrifice skips NI on the contribution. For higher earners, this can be a meaningful difference — salary sacrifice saves an additional 2% NI on contributions above the Upper Earnings Limit.