Refunds are not always possible, so what can be done to unwind the overpayments?
I am often asked if pension contributions paid in error can be refunded to the client or their employer. In most cases, the answer is no, so we need to be sure that any contributions paid are made and calculated correctly.
Let’s look at the scenarios that occur on a regular basis and whether there is anything that can be done to unwind the contributions.
The simplest reason we see for extra pension contributions being made is an error in calculation or a misunderstanding by the client.
This is often where the client knows they want to maximise their tax relievable contributions but forgets it is the gross figure that is taken into account and the net figure that they actually need to pay to the scheme.
This will mean an overpayment that will possibly result in an annual allowance charge. Provided they have sufficient income to get tax relief on the contribution paid, then this is valid and the contribution cannot be refunded.
Tapered annual allowance
The tapered annual allowance has caused havoc for some people trying to maximise their pension savings. Take an employer contribution, for example.
The more the employer pays in, the less annual allowance the client has.
This situation is exacerbated by the fact many will have a pay riseor bonus in March. A percentage-based contribution level could mean that, while the client may have planned their extra contributions well, a better-than-expected bonus or salary increase could push them over their allowance.
It could also force them into the tapered annual allowance, as it would increase their threshold income above the limit. There are no refunds in this situation.
Drop in expected income
This a rarer situation overall but it is more likely to happen to contractors and the self-employed.
As you can only claim tax relief up to your UK relevant earnings, should a client’s earnings suddenly be less than expected, contributions could exceed the amount and they would not be eligible.
These excess contributions are something that can be refunded, although the client will have to wait until the end of the tax year in order to obtain them. The tax relief will be returned to HM Revenue & Customs and any higher rate relief that had been claimed through PAYE will need to be paid back.
The client will then receive the net amount over and above their UK relevant earning back as a “refund of excess lump sum”.
Often, the reason for this request has been because of a client’s confusion between the annual allowance and tax relief, with many thinking you can carry forward unused relief.
It is possible to go back more than one year and get refunds should that be necessary.
The only other time a contribution can be refunded is in the case of a “genuine error”. You would have thought this would be quite a wide definition, perhaps covering some of the cases discussed above where a mistake has been made, but this is not so.
Here, we would be looking at a situation where there was no intention to pay the contribution but it happened anyway. For example, if a bank instruction to cancel a direct debit or standing order was not actioned.
These types of situations are really few and far between but when an employee leaves a company, it can be something that does not quite get through accounts and payroll in time.
Need for advice
All of this is, yet again, something that can usually be avoided with good advice. For those that do end up with a small annual allowance charge on personal contributions then it is not the end of the world, as long as they still claim their tax relief to avoid being out of pocket.
For annual allowance charges created by employer contributions, the client is not technically out of pocket because they would have been taxed at their highest marginal rate if the employer had paid them the money anyway.
I always have to remind people that the annual allowance is just that – an allowance, not a limit. Just like the personal allowance. You do not often see people turning down a salary just because it would take them into the realms of taxation.
Claire Trott is head of pensions strategy at Technical Connection