Pension - Under Recovery of Tax

arcam_man

Before I start – I’m sorry about the long post :sad:.

For the past two and a half years I've worked in a small consultancy since leaving a large multinational in 2016 where I never had to worry about pensions. The company has a relief at source pensions scheme which was set up before I arrived using a financial consultant company. My contributions were defined and passed to the pension company by the financial consultants when I started, which I accepted. However, I'm now concerned that I’ve been under recovering tax since the start and, despite providing many calculations to the financial consultants, I am unhappy with their dismissive response :mad:. As I am a high rate tax payer and I should be able to recover the full tax through both pension (20%) and self-assessment (20%). However, when I look at the current way the contributions and relief on the pension is calculated, it is clear to me I’m not recovering the full amount.

Currently I have to provide at least 5% of my gross contributions to the pension. The existing process defined by the financial consultants is that 80% of this is used to provide the net contribution for the relief at source pension. This appears to assume everyone is a base rate tax payer, and it works fine for most of my other staff. However, what the financial consultants have then instructed to my pension provider is that the pension tax relief is simply the net contribution/4. However, I believe that, as I’ve already paid 40% tax on the net contribution, then the tax relief applied to the pension needs to 20% of the gross contribution, ie the net contribution/3. If I’m correct, then this has resulted in a significant under recovery of tax on my pension since I started the job. I have also claimed the remaining 20% of the 40% tax back from the HMRC in my self-assessment based upon the existing pension contributions. By my calculations I have also under-claimed on this, although to a far lower extent than the under-claim on the pension tax recovery as HMRC would have already taken the pension contribution I’ve been paying (including tax recovery) as 80% of my gross contribution.

Below is an illustration of what I think is the problem (the salary has been rounded):

• Monthly salary: £6000
• 5% of salary: £300
• Current net contribution (80% of above): £240
• Current 20% tax recovery on pension: £60
• Current total employee pension contribution: £300
• Net contribution grossed up to 40%: £400
• 20% pension tax recovery based upon gross contribution: £80
• Corrected total employee pension contribution: £320

Over the 29 months since the start this amounts to an under recovery of the tax directly into the pension of £580. I have also calculated that, over the same period, there is a corresponding under recovery of the remaining high rate tax of £145

I would appreciate the views and advice of anyone who has experience with relief at source pensions schemes, in particular whether or not my assumptions are correct?

Linton

arcam_man wrote: »

• Monthly salary: £6000
• 5% of salary: £300
• Current net contribution (80% of above): £240
• Current 20% tax recovery on pension: £60
• Current total employee pension contribution: £300
• Net contribution grossed up to 40%: £400
• 20% pension tax recovery based upon gross contribution: £80
• Corrected total employee pension contribution: £320

Over the 29 months since the start this amounts to an under recovery of the tax directly into the pension of £580. I have also calculated that, over the same period, there is a corresponding under recovery of the remaining high rate tax of £145

I would appreciate the views and advice of anyone who has experience with relief at source pensions schemes, in particular whether or not my assumptions are correct?

In calculating tax relief on pensions you should always start with the gross contribution. If you dont you can easily get very confused as you seem to have done here.


Gross payment into pension: 5% of salary=£300 made up of £240 net contribution and £60 basic rate tax relief .
HR tax paid on £300: £60


This £60 is claimed via your tax return or by contacting HMRC directly.

arcam_man

Thanks Linton,

I totally agree with your comments regarding starting with gross. However I believe the gross contribution is not £300 - as I'm a higher rate tax payer the gross is actually £400 (£240 net plus £160 tax). If the £240 x 1,25 figure is used it merely brings it back to what a basic rate tax payer gross would be, and it will be impossible to recover the £160 tax. This is exactly where I believe the problem lies,

Linton

arcam_man wrote: »

Thanks Linton,

I totally agree with your comments regarding starting with gross. However I believe the gross contribution is not £300 - as I'm a higher rate tax payer the gross is actually £400 (£240 net plus £160 tax). If the £240 x 1,25 figure is used it merely brings it back to what a basic rate tax payer gross would be, and it will be impossible to recover the £160 tax. This is exactly where I believe the problem lies,

No I am afraid you are incorrect. The total amount of money that should be going into your pension is £300 - 5% of your salary. You have already been taxed on this £300 at 40% = £120, £60 basic rate and £60 HRT.


This tax should be returned by HMRC. It is: £60 is paid by HMRC into your pension which added to the £240 you contribute from your net pay gives £300. The additional £60 from the higher rate tax is returned to you personally outside the pension. You can hardly expect to be given tax relief on money that is returned to you.


The reason for this apparent complexity is that the process is designed to be simple for basic rate tax payers who comprise the great majority of pension contributors -they simply pay net and HMRC automatically add the 20% tax (25% of their net contribution). Higher rate tax payers also pay in net of basic rate tax only, since that is how the system works. Their higher rate rebate is paid separately.

Dazed_and_confused

There is no "extra 20%" for higher rate taxpayers.

The gross contribution to a relief at source scheme just increases the amount of basic rate tax you can pay. Which can in turn reduce the higher rate tax payable but if you have contributed £3,600 (gross) and are only liable to higher rate tax on say £1,000 you aren't getting an extra 20% on the £3,600.

Do you complete Self Assessment returns and if not have you contacted HMRC about these pension payments yet?

Linton

I have thought iof another way of looking at the situation which may help.


As D and C points out you may not be due higher rate relief on all your contribution. However lets assume you are, as you would be with a a £6K/month salary and a 5% contribution......


You want £300 gross in your pension. You do not have £300 gross, you only have £180 with the remaining £120 having been taken as tax. So what you do is to borrow £60 and contribute £240 net which is increased to £300 inside your pension by HMRC. At a later date HMRC give you back your £60 outside your pension so you can repay your debt.


This is also exactly how it works if you make a contribution to a personal pension.

arcam_man

Hi Dazed and confused,

There certainly is a further 20% recovery to achieve the 40% through HMRC. I did this with a large pension contribution 2 years ago when I left my last company with a large hand out and wanted to recover all the tax. You recover the first 20% which is added to the net pension contribution by the pension company, and the further 20% you recover directly through HMRC usually through the tax returns - although you can do this directly through HMRC. I have also included the current company pension on the tax returns and the additional 20% is paid back through an increase to the personal allowance: This is described in many places on the internet, including:the GOV.UK site on pensions.

Dazed_and_confused

Sorry but you are wrong.

HMRC do not repay an extra 20% pension tax relief.

It may be your personal circumstances are quite simple and the tax relief due is roughly 20% but they do not pay a flat 20%.

Your tax is re-calculated taking into account the pension contribution. Your basic rate tax band is increased by the gross amount of the pension contribution and this in turn reduces any higher rate tax payable.

If HMRC simply paid an extra 20% it would mean,

1) You would only need to pay higher rate tax on £1 to get potentially tens of thousands of pounds of higher rate tax relief

2) Those people due an additional 40% relief from HMRC would not get the relief they were entitled to

Dazed_and_confused

I have also included the current company pension on the tax returns and the additional 20% is paid back through an increase to the personal allowance:

Sorry again but you have fundamentally misunderstood a few things here.

Your Personal Allowance can never be increased above the standard amount.

Your tax code allowances can take into account pension relief but that is an entirely different things to your Personal Allowance.

More importantly though HMRC never give pension tax relief for one year through the tax code of a different year.

When you include the pension contributions on your tax return you receive any tax relief due through your Self Assessment calculation for that year i.e. your basic rate band is extended.

HMRC may also amend the following years tax code to include pension relief but that is just a provisional amount of relief for the next tax year (based on the tax return you have submitted). It is not allowing tax relief in respect of the pension contributions included on the tax return.

arcam_man

Dear Linton,

Sorry - I don't seem to be getting this point through. £300 is 5% of the gross salary therefore it hasn't been taxed and is actually not really relevant here. The net (after tax) deduction from salary in the way carried out is £240. Therefore this actually equates to a deduction from the gross salary of £400. In line with my calculations this is what the 20% tax contribution to the pension should be based upon - not £300. Therefore the tax recovery through the addition to the pension is £400 x 0.2 (£80) and the further tax recovery through HMRC is also £80. In this way I would recover the total £160 tax (£400 - £240). If the base rate calculated figure of £300 was used (as is happening) then I would only recover £60 through the pension and a further £75 though additional HMRC relief ( £300 x 1.25-£300). In total I would only then recover 34% of my tax.

Dazed_and_confused

Linton is correct. Your gross pension contribution is £300.

You actually paid out £240 in the first place to get £300 in your pension fund.

You can then claim higher rate tax relief from HMRC. For simplicity we will say this equates to a £60 reduction in your personal tax liability.

So you are now better off by £60.

So ultimately you have £300 in your pension fund which really cost you £180.