UC and Pension Drawdown

calcotti

WillowCat said:

You can make a tax reclaim if your overall taxable income is under the personal allowance, but if you have any earned income in the same tax year UC will treat the tax reclaim as earned income.

I'd forgotten that. Treatment of tax refunds is one of my 'pet hates' in UC, completely morally unjust in my opinion.

Croeso69

calcotti said:

WillowCat said:

You can make a tax reclaim if your overall taxable income is under the personal allowance, but if you have any earned income in the same tax year UC will treat the tax reclaim as earned income.

I'd forgotten that. Treatment of tax refunds is one of my 'pet hates' in UC, completely morally unjust in my opinion.

But the tax refund is in respect of too much tax deducted previously and the UC in those periods were higher than they should have been (had the correct lower tax been deducted) so this recoups the historic UC overpayment. 

Tax credits are based on gross income so tax overpayments and refunds are ignored. UC is based on net income, so tax deductions and refunds need to be allowed for.

Both methods are consistent and morally just. 

calcotti

Croeso69 said: But the tax refund is in respect of too much tax deducted previously and the UC in those periods were higher than they should have been (had the correct lower tax been deducted) so this recoups the historic UC overpayment. 

That is the logic behind it and would make sense if claimant was on UC at the time the tax was originally deducted which, as you say, would have resulted in higher UC.

In my experience however this situation more often arises when someone claims UC and then gets a tax refund for past earnings from before claiming UC. The tax refund is because the tax originally deducted is was never due but was collected because that’s how PAYEworks. However the UC is then reduced by the tax refund which means that claimant has effectively still been taxed on that earlier income which is morally wrong, in my opinion. That will have been the case for many people in the past year who have claimed UC for the first time.

in the case of a tax refund for tax deducted from a pension payment on which tax was never due anyway it is clearly wrong. Say they take £1000 pension drawdown, which isn’t treated as income for UC, but HMRC deduct £150 so OP only receives £850. This has no impact on UC because it’s treated as capital. When the £150 tax is refunded OP potentially loses £94.50 of UC. It may be that there has been no earned income in the year in which case the problem doesn’t arise and it may be that even if it does arise it’s covered by a Work Allowance. However the underlying rule is morally wrong in my opinion.