A look at some of the circumstances in which a refund of excess contributions lump sum can and cannot be claimed
Logan and Noah work in partnership as self-employed painters and decorators. In recent years they have taken an equal share from their profits of around £30,000 per annum. With plans to retire in the next five years, they have started making large pension contributions, usually at the start of each tax year. On 10 April 2018, they each paid £24,000 net to their relief at source pension schemes.
Their most recent client works in pensions customer service and, following a little shop talk, Logan and Noah are worried they may have overpaid to their pensions and have come to you for advice.
Back in May 2018, Logan fell from a ladder which left him injured and unable to work for two months. Noah took on a temporary employee for this period. Logan agreed his share of the profits should be reduced by these additional costs.
If Logan reaches the end of the 2018/19 tax year and his relevant earnings are less than the gross pension contribution he has paid, the excess amount is not entitled to any tax relief.
An individual paying a pension contribution is entitled to tax relief on the higher of the basic amount of £3,600 gross or up to 100 per cent of their relevant earnings in the tax year the contribution is paid. Contributions in excess of this amount are not entitled to tax relief.
Pension contributions can be paid at any time in the tax year, based on anticipated earnings for the whole tax year. Where a large contribution is paid early in the tax year but then the earnings to make it eligible for tax relief do not materialise, HM Revenue & Customs guidance allows a refund of the excess contribution.
This is known as a refund of excess contributions lump sum.
You tell Logan he can ask for a refund of excess contributions lump sum. His pension scheme administrator (once they have sufficient evidence of the correct earnings figure) must return any excess tax relief claimed through relief at source to HMRC, and if scheme rules allow, they can refund the overpaid contribution to Logan.
You tell Logan he must wait until after the end of the 2018/19 tax year to claim any refund, as his final relevant earnings figure needs to be established so the excess amount can be accurately calculated.
Although a refund of excess contributions lump sum can be paid up to six full tax years after the excess contribution was paid, you recommend Logan contacts his scheme as soon as his 2018/19 final earnings figure is known.
Noah took an uncrystallised funds pension lump sum to pay debts in January 2018. While aware this triggered the money purchase annual allowance, he believed this only restricted contributions for the remainder of the 2018/19 tax year.
You explain that, once triggered, the MPAA limit applies for all future tax years. So, Noah’s contribution exceeds the £4,000 allowed.
As his contribution does not exceed his relevant earnings, there is no option for a refund of excess contributions lump sum.
Annual allowance rules do not allow any refunds of AA excess to reduce or avoid any AA charge. As Noah’s pension savings exceed the MPAA limit (there is no option to use carry forward to increase the MPAA limit), he must pay the relevant charge through self-assessment.
Noah’s scenario does not meet the conditions for mandatory scheme pays; his AA charge would need to exceed £2,000 and his pension input would have to exceed £40,000.
You suggest he contacts his pension scheme to ask if they will agree to scheme pays on a voluntary basis, meaning the scheme would reduce Noah’s pension fund to meet the cost of the AA tax charge rather than Noah having to fund this himself. So, in Noah’s case, he is not entitled to a refund of any part of his contribution. He has exceeded his AA and must report this in his self-assessment tax return.
Where fluctuating earnings are concerned, making large pension contributions early in the tax year can lead to consequences later. You suggest to Logan that he considers making smaller, regular payments throughout the year, then meets with you in January to discuss making a final payment once his income figure is clearer.
Noah is stuck with his MPAA limit, and you can’t reverse this situation. He is a casualty of the pension freedoms and is a prime example of why individuals should be seeking financial advice.
Once Noah uses his annual MPAA limit you offer to help him with alternative investment options as part of his retirement planning, such as making third-party pension contributions for his wife, or using Isas, EISs or VCTs.
Jacqueline Clezy is technical manager (pensions) at Prudential