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Accidental overpayments into pension

If I accidently paid too much into the pension by exceeding the 60K plus any carry forward, would this then mean that I end up paying tax twice on the same money and I could end up paying some ridiculous rate like 90% worst case? (income tax on way in and on way out)

If this happens, can you ask the pension provider to pay it back in the same tax year or are you stuck with the situation? 

Comments

  • Pat38493
    Pat38493 Posts: 3,122 Forumite
    Tenth Anniversary 1,000 Posts Name Dropper Combo Breaker
    edited 23 October 2023 at 3:36PM
    xylophone said:
    Thanks - but regarding my question, if the contributions can't be refunded, which seems like it's often the case, does this mean I would pay income tax twice on the same money?  So worst case I could pay 45% income tax on the overpayment, and then another 45% on the way out?  This is obviously a worst case scenario but you see what I mean?

    I am trying to understand the tax consequences of doing this - I've seen a few suggestions that in rare situations it might make sense to deliberately overpay into the pension, but if you have to pay income tax twice, surely that would be crazy?
  • Depends on your method of contribution e.g.  - is it salary sacrifice ? I don’t believe there is a situation where you will pay tax twice. You may also be able to use “scheme pays” mechanism , where your pension provider will pay any tax due from contributing more than annual allowance - directly from pension fund -rather than you having to pay it from taxable earnings. What more information can you provide? 
  • Pat38493
    Pat38493 Posts: 3,122 Forumite
    Tenth Anniversary 1,000 Posts Name Dropper Combo Breaker
    Depends on your method of contribution e.g.  - is it salary sacrifice ? I don’t believe there is a situation where you will pay tax twice. You may also be able to use “scheme pays” mechanism , where your pension provider will pay any tax due from contributing more than annual allowance - directly from pension fund -rather than you having to pay it from taxable earnings. What more information can you provide? 
    I don't think you are understanding my quesiton (or I am confused).

    As far as I know, all withdrawals from DC pension pots are taxed at your marginal tax rate, apart from any tax free cash available.

    Therefore to keep it simple, let's say I already claimed the maximum tax free cash allowable £268K or whatever so I am no longer entitled to any further tax free cash.

    Let's say I think overpaid £10K more than I should have into the pension.

    As I understand it, I will get charged an annual allowance charge in the year of the overpayment of 4K if my marginal tax rate is 40%.

    Then, some years later, I take that 10K back out of the pension - I will then be charged at my marginal tax rate again, so if my marginal tax rate in retirement is 20%, I will have paid 60% tax on that money in the end?
  • Let's say you start out with 14k. You pay 10k too much into a pension, then the 4k penalty charge. You draw out the 10k, taxed at 20% and you have 8k. You have turned 14k into 8k - it's about a 43% loss. If you are 40% taxpayer in drawdown, 14k turns into 6k, so 57% loss.
    If you take 10% off something 10 times you are not left with zero...

  • Pat38493
    Pat38493 Posts: 3,122 Forumite
    Tenth Anniversary 1,000 Posts Name Dropper Combo Breaker
    Let's say you start out with 14k. You pay 10k too much into a pension, then the 4k penalty charge. You draw out the 10k, taxed at 20% and you have 8k. You have turned 14k into 8k - it's about a 43% loss. If you are 40% taxpayer in drawdown, 14k turns into 6k, so 57% loss.
    If you take 10% off something 10 times you are not left with zero...

    Ok but looking at it from that way, if it was not an overpayment, I would still have the 4K plus the 8K so I would end up with an 14% loss.... 

    So if I had tax free cash available form the pension then, it would work out pretty even in the end then - i.e. I would get no advantage but no disadvantage (other than not being able to access the money until pension age)?
  • No penalty on the way in, and 25% tax free on the way out is how most of us run our pensions.
    Either you would pay the whole 14k into the pension (if you had room) or just 10k. The calculation works the same:
    Basic rate taxpayer
    10k in. 2.5k tax free out + 7.5k x 0.8 = 6k out  You have 8.5k and have paid 15% tax instead of 20%. The oft quoted 6.25% benefit, since you have turned 8k into 8.5k

    Or higher rate earner, basic rate pensioner:
    10k in. 2.5k tax free out + 7.5k x 0.8 = 6k out  You have 8.5k and have paid 15% tax instead of 40%. You have turned 6k into 8.5k, a 41.8% uplift

    Or higher rate earner, higher rate pensioner:
    10k in. 2.5k tax free out + 7.5k x 0.6 = 4.5k out  You have 7k and have paid 30% tax instead of 40%. You have turned 6k into 7.5k, a 25% uplift

  • Pat38493
    Pat38493 Posts: 3,122 Forumite
    Tenth Anniversary 1,000 Posts Name Dropper Combo Breaker
    No penalty on the way in, and 25% tax free on the way out is how most of us run our pensions.
    Either you would pay the whole 14k into the pension (if you had room) or just 10k. The calculation works the same:
    Basic rate taxpayer
    10k in. 2.5k tax free out + 7.5k x 0.8 = 6k out  You have 8.5k and have paid 15% tax instead of 20%. The oft quoted 6.25% benefit, since you have turned 8k into 8.5k

    Or higher rate earner, basic rate pensioner:
    10k in. 2.5k tax free out + 7.5k x 0.8 = 6k out  You have 8.5k and have paid 15% tax instead of 40%. You have turned 6k into 8.5k, a 41.8% uplift

    Or higher rate earner, higher rate pensioner:
    10k in. 2.5k tax free out + 7.5k x 0.6 = 4.5k out  You have 7k and have paid 30% tax instead of 40%. You have turned 6k into 7.5k, a 25% uplift

    Sorry to resurrect this a few weeks later, but one other thing - the discussion on this thread, does this kind of mean that it makes sense to overpay into the pension if you are getting salary sacrifice and NI sharing benefits on the way in?  I'm thinking even if it works out roughly the same from an income tax point of view, you have still saved the NI part?
  • beeza650
    beeza650 Posts: 197 Forumite
    Eighth Anniversary 100 Posts Name Dropper Combo Breaker
    It depends on 3 things (a) what do you mean by NI sharing benefits (b) what your marginal rate will be at drawdown and (c) how well your pension performs vs what else you would have done with the money.

    If by NI sharing benefits you mean your company gives you all the employer's NI and apprenticeship levy that they save by you making additional contributions via salary sacrifice and you stay below the 40% tax bracket when you take out the pension then you could well be better off overpaying. More so when you factor in that 25% of any pension growth is tax free, that there's no tax as it grows so that bit's compounded and finally that CGT allowance is falling so investing the money elsewhere an not paying your marginal rate of income tax on it or CGT could be a concern.

    I am in the same boat, albeit I'm contractor working through an umbrella company. I can exceed the £60K a year and avoid paying the marginal rate of 16.3% (employers NI + employees NI + apprenticeship levy) on that contribution but I will be taxed on the way out again. If I stay under the 40% bracket and take into account 25% tax free then the overall rate of income tax is 15%. A 1.3% saving + you don't pay the tax till you take the money so it the investment is essentially "tax free" until you withdraw with the benefits of compounding that entails. Finally, pensions are a good vehicle to pass income on when you die and also, by keeping your income below £100k threshold means you get tax free childcare.

    HOWEVER!
    Stray beyond the 40% tax bracket in retirement - or the rules change and you could be out of pocket.
  • Pat38493
    Pat38493 Posts: 3,122 Forumite
    Tenth Anniversary 1,000 Posts Name Dropper Combo Breaker
    beeza650 said:
    It depends on 3 things (a) what do you mean by NI sharing benefits (b) what your marginal rate will be at drawdown and (c) how well your pension performs vs what else you would have done with the money.

    If by NI sharing benefits you mean your company gives you all the employer's NI and apprenticeship levy that they save by you making additional contributions via salary sacrifice and you stay below the 40% tax bracket when you take out the pension then you could well be better off overpaying. More so when you factor in that 25% of any pension growth is tax free, that there's no tax as it grows so that bit's compounded and finally that CGT allowance is falling so investing the money elsewhere an not paying your marginal rate of income tax on it or CGT could be a concern.

    I am in the same boat, albeit I'm contractor working through an umbrella company. I can exceed the £60K a year and avoid paying the marginal rate of 16.3% (employers NI + employees NI + apprenticeship levy) on that contribution but I will be taxed on the way out again. If I stay under the 40% bracket and take into account 25% tax free then the overall rate of income tax is 15%. A 1.3% saving + you don't pay the tax till you take the money so it the investment is essentially "tax free" until you withdraw with the benefits of compounding that entails. Finally, pensions are a good vehicle to pass income on when you die and also, by keeping your income below £100k threshold means you get tax free childcare.

    HOWEVER!
    Stray beyond the 40% tax bracket in retirement - or the rules change and you could be out of pocket.
    Thanks yes - what I mean is that when I use Salsac, the company shares half (not all) of the NI savings with me.  I tried to calculate this using a formula from research on the internet and my spreadsheet gets close to the amount they increase the payments by when I change my contributions (but it's not exact and I'm not sure why).

    I guess it's quite complicated because if I take Secret2ndaccountant's example where he says I "turned 14K into 8K", in that example if I had just not overpaid into the pension, I would have ended up with 10K, so my OP statement was correct in that I am paying income tax twice, albeit not at the full rate on the second bite due to tax free cash portion.

    This though didn't take into account salsac and NI reductions, but it would have to be significant to outweigh the disadvantage as you say.  Your NI savings would be higher than mine.  I haven't done the full maths but I suspect my case would be more like close to break even.

    I have no intention of deliberately overpaying my pension but my company is doing redundancies and if I'm included, depending on timing, my contractual severance package might trigger the taper allowance which might result in my having already paid too much into the pension.  Therefore next tax year I might put my pensions much lower for the first half of the year, then depending what happens I can ramp them up to max later in the year.
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