Tax relief error could see Government come after pensions

The Government has discovered a pension mistake that could mean it starts dipping into pensions to recoup tax.

There is a small chance that the Government could come after your pension savings through no fault of your own.

According to Rachel de Souza, from accountancy firm RSM, a number of workplace pensions have made a mistake in reporting tax relief that means the relief has been paid twice.

Normally, when you make a contribution to your pension it is from your take-home pay, after income tax has been deducted.

Then, once the money is in your pension, the Government adds back the Basic Rate of tax that you paid on the money. Your employer may also make a contribution, but there is no tax relief on that as no tax had been paid.

For example, if you make a £80 contribution then the Government adds £20 – the amount you paid in Income Tax on the £80 you paid in. If your employer adds in another £100 that gets no tax relief, but you end up with £200 in total in your pension.

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However, some companies make arrangements for the tax relief to be paid upfront.

This is when your pension contributions are made via ‘salary sacrifice’. In this case, your whole pension contribution is made by your employer, with you taking a gross pay cut to reflect the amount being paid into your pension.

For example, your employer pays £200 gross into the pension, and you take a gross £100 a month pay cut.

This saves both you and your employer from paying National Insurance on the £100 that would have come from you. However, the Government doesn’t add any tax relief as no tax has been paid on the £200.

But, there may be a problem.

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Pensions receive double tax relief

“Worryingly, the Government and the pensions industry have now woken up to the fact that in many salary sacrifice cases data has been provided to the pension scheme incorrectly, resulting in the pension scheme also claiming tax relief on the contributions,” says de Souza.

In practice, this means that, as in the second example above, your employer pays £200 into your pension for you and you take a £100 pay cut.

No tax relief is due as no income tax had been paid on the £200. However, the fact the contribution is being made via salary sacrifice hasn’t been made clear to the pension provider. So, they add tax relief too.

“In other words, pension pots have had double tax relief,” says de Souza.

If this has happened, then the Government wants the extra tax relief back.

The tax relief paid on pension contributions costs the Government around £8 billion a year, so they don’t want to be paying any of it incorrectly.

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“Not surprisingly, the Government wants this overpaid tax relief back, which is fair enough,” says de Souza. “If I had inadvertently paid my plumber twice, I would expect him or her to return the amount overpaid, and the concept here is no different.”

How common is this?

“I can see how this ‘could’ happen, though I must admit I hadn’t heard that it had happened,” says Steve Webb, director of policy at Royal London and former pensions minister.

“I’ve no idea how common this might be or whether it’s just an isolated example.”

As yet it is unclear how many salary sacrifice pension schemes may be affected by the problem. HMRC have told LoveMONEY that "there will always be a certain proportion of excess relief claims" and this can be for a number of reasons with misreported salary sacrifice being one of them.

"Unfortunately, HMRC doesn't collect data on how often it has to claw double tax relief back so no-one know-how much double tax has been reclaimed, nevermind how much has been double paid with no-one noticing.

If you have been receiving double tax relief, you should be able to see it on your pension statements.

How will the money be recouped?

The problem is, if double tax relief has been being paid it could have been going on for years. If the Government then takes a tax repayment out of the pension pot it could mean a huge hit to that person’s pension savings and plans for the future.

“The tax repayment will come out of the pension pot, which will shrink by the amount of overclaimed tax,” says de Souza.

“Annual projections of pension income that individuals have used to plan their retirement will turn out to be badly overstated, and existing pensions could see their income fall. This could get really ugly.”

Have you received double tax relief? If so let us know in the comments below.

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