There are times when a pension contribution may be regretted and a client may want to turn back the clock but, explains Les Cameron, there are only a few exceptions to HMRC’s ‘no-refunds’ policy.
Certain aspects of pension saving are generally understood. There are two conventional wisdoms – first, that paying into a pension provides a future valuable benefit and, second, that there is rarely the option to request a refund of these payments.
While, on the face of it, requesting a refund may sound unusual, instances do arise where payments are made in error and there are other instances when making a pension contribution may be regretted and the ability to turn back the clock would certainly be useful.
While not an exhaustive list, times when a pension contribution could be regretted include:
* where a client has received a pension savings statement highlighting they have exceeded their available annual allowance;
* where a client has continued to receive large employer contributions, having previously triggered the money purchase annual allowance;
* where a client has fully used their annual allowance but is then made redundant and the income spike means they have had their annual allowance tapered; and
* where a client will breach the Lifetime Allowance and, while they ideally needed to apply for fixed protection 2016, they have instead paid a pension contribution in tax year 2016/17.
The simplest solution in each of these circumstances would be to unwind the client’s ‘offending’ pension contribution – but is this allowed?
Requesting a refund
A pension contribution can be refunded but only in limited circumstances. First, if a client pays a contribution that exceeds their relevant earnings, HMRC rules allow a refund of the excess amount. This is known as a ‘refund of excess contributions lump sum’.
A refund may also be allowed where the pension scheme is not entitled to the contribution – for example, if the client instructed their bank or building society to cancel a direct debit and the instruction was not carried out in time. As the scheme was not entitled to the contribution in the first place, it is not technically scheme money and can be refunded as though it had never been paid to the scheme.
Similar provisions exist for members who opt out of auto-enrolment within the 30-day deadline. They are treated as never having joined the scheme and any contributions paid to the workplace pension scheme can be refunded.
But these are the only circumstances under which a pension contribution can be refunded. The rules around breaching annual allowance do not allow refunds. If a client exceeds the annual allowance, then they must address this position by reducing or absorbing the excess amount using carry forward – and remember, there is no carry forward for money purchase annual allowance excesses. If an excess remains, then tax is reported and paid through self-assessment.
A refund other than in those permitted scenarios described above is classed as an ‘Unauthorised Payment’ and would therefore trigger a penal tax charge, with the refunded contribution still using up the client’s annual allowance.
Help at hand
The good news is that help paying any annual allowance charge may be at hand – but again these rules are not straightforward. If there is an annual allowance tax charge due, the client can pay the charge from their own purse although they may also have the option to request their scheme pays the tax charge.
At a scheme’s discretion, a voluntary payment of the tax charge can be made from the member’s fund but schemes are not obliged to allow this. In some circumstances, the scheme can be forced to pay some of the charge, under ‘mandatory scheme pays’ rules – but there is a limit on the maximum tax charge the member can ask their scheme to pay.
The ‘mandatory scheme pays’ rules for annual allowance are not new but, in addition to the annual allowance, we now also have the money purchase annual allowance and the tapered annual allowance and this is where it gets more complex.
In terms of the rules, an individual can elect to notify their scheme to pay some or all of their annual allowance charge liability in return for an appropriate reduction in their scheme benefits if they meet the following conditions:
* their annual allowance charge liability for the tax year exceeds £2,000 and;
* their pension input amount for the pension scheme for the same tax year has exceeded the annual allowance amount in section 228 Finance Act 2004 (£40,000 for 2016/17 – meaning the tapered and/or money purchase annual allowances are ignored).
It is worth noting that, for annual allowance purposes only, tax year 2015/16 is split into two ‘mini’ tax years – the pre-alignment tax year (6 April 2015 to 8 July 2015) and the post-alignment tax year (9 July 2015 to 5 April 2016). For tax year 2015/16, the condition in the bullet immediately above is met if the individual’s pension input amount for the pre and post-alignment tax years for the pension scheme exceeded £40,000.
Where an individual’s annual allowance charge liability has been triggered by the money purchase annual allowance, the individual cannot elect to notify the scheme administrator unless the individual’s annual allowance charge, worked out using the standard annual allowance, would have exceeded £2,000.
An example
An additional rate taxpaying client has pension inputs of £42,000 into a single pension scheme. If the client is subject to a tapered annual allowance of £10,000, the tax charge is £32,000 x 45% = £14,400. As this figure is over £2,000, it meets the conditions for ‘mandatory scheme pays’ and the scheme can be forced to pay some of the charge.
If the client is subject to the money purchase annual allowance, however, the outcome is different. Although the client’s tax charge is £14,400, the rules mean we have to work out the amount of charge based on the standard annual allowance of £40,000 (£2,000 x 45% = £900). As the tax charge is less than £2,000, then no ‘mandatory scheme pays’ notice can be raised.
Of course, in either case, the scheme may still offer to pay the client’s tax charge on a voluntary basis.
In summary
Making a pension contribution carries hugely valuable benefits as part of a client’s overall financial planning but due to an unforeseen change in circumstances, what may have initially looked like a good idea can have the potential to turn into a tax headache. And with only a few exceptions, HMRC rules unfortunately do not allow to us to turn back the clock on pension contributions.
Les Cameron is head of technical at Prudential
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