Thousands of Britons could face large bills because they do not understand a question on their tax return.
HMRC has flagged up to pension schemes that some employees may unwittingly be failing to report all their pension contributions on their tax return. The oversight could result in large tax bills in due course when the taxman catches up with them, warns Steve Webb, director of policy at Royal London.
The problem occurs when higher-rate taxpayers fill in the pension contributions section of their tax return, which covers growth in their defined benefit pension rights as well as cash paid into defined contribution pots.
The form includes a question asking whether they have paid in money in excess of the annual allowance, which is the amount you can pay in and receive full tax relief. This should be reasonably straightforward for most people, but for those on higher incomes who may be affected by the tapered annual allowance (see box below) the rules become extremely complicated.
Webb says: “We’ve long suspected people are putting a zero there or leaving a blank because they don’t understand the question, let alone how to calculate the answer.”
Excess contributions over and above the annual allowance are taxed at 40% and 45% respectively for higher rate and additional rate taxpayers. Anyone with several years of undeclared excess contributions could be facing a tax bill of “tens of thousands of pounds” if the HMRC catches up with them, he adds.
In its latest monthly newsletter to pension schemes, HMRC says it knows “that scheme members are forgetting to declare details of their annual allowance charge on their self-assessment returns”.
The use of the word “forgetting” is extraordinary, Webb says, but it might indicate that HMRC will view non-declarations as genuine mistakes and take a relatively lenient line in regard to those scheme members.
He continues: “The shocking saga around the annual allowance for pension tax relief gets worse. We now have HMRC admitting that they know that people are forgetting to put information about their pension tax bills on their annual return. But filling in this tax return question requires individuals to understand the system, especially if they are affected by the tapered annual allowance.
“Thousands of people could be set to face huge tax bills because they have innocently failed to declare this information on their tax return. HMRC needs to get to the bottom of how many people have failed to declare this information and contact them immediately. And the next government needs to radically simplify the tax relief limits, to avoid this sort of situation happening again.”
Pension contributions: how do annual allowance and the tapered reduction work?
The annual allowance is currently £40,000 a year, but this may be reduced or tapered if your ‘threshold income’ (your annual income before tax less any personal pension contributions and ignoring any employer contribution) is over £110,000.
If your threshold income is above £110,000, then the taper will kick in if your ‘adjusted income’ is above £150,000. Adjusted income is basically your total annual taxable income (including dividends, savings interest and rental income) before tax, plus the value of your own and any employer pension contributions.
If it is above £150,000, the annual allowance will reduce by £1 for every £2 that your ‘adjusted income’ exceeds £150,000. Once it exceeds £210,000 you have just £10,000 of annual allowance.