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Remember your pension in your self-assessment!

Updated 04 May 2020

Nick Green
Financial Journalist

If you’re a higher-rate taxpayer with a workplace or personal pension, then submitting a tax-return (and doing it properly) is a must. Otherwise you’ll miss out on valuable benefits, and might also face hefty tax penalties. Article by Nick Green.

Claiming higher rate pension tax relief

Higher-rate taxpayers are still overpaying hundreds of millions of pounds in tax by failing to claim their full pension tax relief via their self-assessment. According to Royal London, these individuals are also risking higher tax bills by unwittingly exceeding their pension annual allowance, or by doing so and failing to report it on their tax return.

If you usually complete a tax return, you should already have received your notice from HMRC to complete your self-assessment for the tax year just gone (2019 to 2020). And although the deadline for this is still a long way away (midnight on 31 January 2021), it is predicted that thousands of taxpayers will again miss out on tax relief owed to them, or otherwise incur penalties by omitting vital information.

Why are higher earners missing out on tax relief?

HMRC don’t exactly go out of their way to remind you that you can claim higher-rate tax relief on pension contributions, or that you have to fill in a self-assessment tax return in order to get it.

Hopefully most people with a pension will know that they receive basic rate tax relief on every contribution they make. If you’re a basic rate taxpayer, then this 20 per cent tax relief will usually be added automatically. However, if you pay higher rate (40 per cent) or additional rate (45 per cent), you’ll need to claim the extra 20 or 25 per cent via your tax return. Note that this money won't be paid directly into your pension pot, but will be repaid to you in one of three ways:

  • a tax rebate
  • a change in your tax code (so you pay less tax next year)
  • a reduction in this year's tax bill

You must do this every year that you pay tax at these higher rates, so if you haven't previously completed a self-assessment, you may have unpaid tax relief in arrears. You can make claims for up to four previous tax years, which may total many thousands of pounds. Anecdotal evidence from many financial advisers indicates that a large number of their clients unknowingly have windfalls of this kind waiting for them.

Way back in 2012, Prudential estimated that some 250,000 higher and additional-rate taxpayers failed to claim their full tax relief, amounting to around £300m every year in overpaid tax. Eight years on, this figure is likely to be much the same, given that many higher-rate taxpayers who are employees still do not complete a tax return – which is the only way to claim this relief. HMRC does not usually prompt non-self-employed people to submit a self-assessment, so if you are a higher-rate taxpayer who pays solely via PAYE, then you must actively request to submit a tax return if you want to claim the free money.

It’s often said that higher-rate taxpayers who earn a single income through employment don’t have to complete a tax return. Technically this remains true, in that HMRC won’t chase you or actively penalise you if you don’t do it. But – and it is a big but – failing to claim that tax relief costs such taxpayers around £1,000 or more each per year, which is quite some ‘penalty’.

Exceeding the annual allowance (and failing to report it)

The second big reason to take extra care over your tax return is the chance that you might have exceeded your pension’s annual allowance. The annual allowance is the amount you can pay into your pension in a single tax year and still claim tax relief, and is currently £40,000 for most people. If you pay in more, you’ll face a tax charge.

You need to be especially careful if you’ve already begun to draw upon your pension (even small amounts) as this will reduce your annual allowance to £10,000. Similarly, if you earn £150,000 or more in any given tax year, this will begin to ‘taper’ your annual allowance, down to as little as £10,000. Anyone earning £100,000 or more should be careful, as other income such as dividends or employer pension contributions can increase the adjusted total above the threshold.

If you have knowingly exceeded the annual allowance, it is your responsibility to disclose this on your tax return. However, according to a freedom of information request by Royal London, in 2016-17 over a thousand people exceeded the allowance and failed to tell HMRC.

Does your pension scheme include ‘scheme pays’?

One reason why people may omit to mention excess pension contributions is that their pension scheme has a feature called ‘scheme pays’. This simply means that the scheme will automatically pay any tax charge on contributions above the annual allowance. However, even when this feature is in place, taxpayers still need to disclose the excess on their tax return, or be penalised accordingly.

Could high earners get a pension tax windfall?

The Treasury has proposed raising the threshold at which the annual allowance taper kicks in. Currently tapering begins for anyone with a 'threshold income' of above £110,000 and an adjusted income (i.e. taking into account other types of income) of above £150,000. Under the new proposals, tapering would only begin at a threshold income of £150,000. This is mainly to benefit senior NHS staff (i.e surgeons and doctors) who have been unable to work overtime without risking their annual allowance. The threshold change would rectify this, but would apply to all higher-rate and top-rate taxpayers, thus saving up to an extra £40,000 in tax.

Why most higher-rate taxpayers should opt to complete a tax return

Tax returns are often seen as a chore, and it's understandable that few people look forward to completing them. But the reality is that, for higher earners, completing a self-assessment accurately is often a route to paying less tax and boosting your retirement income at the same time.

Former pensions minister Steve Webb, now director of policy at Royal London,  said: ‘Filling in your tax return can be challenging enough, but the complexity of the rules around pension tax relief for higher earners is a particular nightmare. 

‘The good news is that some higher earners can claim additional tax relief provided that they put the right information on their tax return. But others need to make sure they report contributions in excess of their annual allowance and pay the tax due now.’

In summary: if you are a higher earner (£50,001 a year or over) and don't normally complete a tax return, then you really should – because you're losing out on valuable pension contributions by not doing so.

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About the author
Nick Green is a financial journalist writing for Unbiased.co.uk, the site that has helped over 10 million people find financial, business and legal advice. Nick has been writing professionally on money and business topics for over 15 years, and has previously written for leading accountancy firms PKF and BDO.