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Key pension traps advisers can help clients avoid

Key pension traps advisers can help clients avoid
Photo by Anna Nekrashevich from Pexels

HM Revenue & Customs refunded £142m in tax overpayments on pension contributions in 2021, with £42m of this being repaid in the last quarter of the year alone – the equivalent of £3,107 per saver in overcharged tax, according to calculations from Quilter.

The majority of these overpayments happened as a result of emergency tax codes being applied to PAYE as people who were still in the workplace accessed their pension savings for the first time, or returned to work after vesting part or all of their pension. This is something Jon Greer, head of retirement policy at Quilter, describes as “a little-known quirk of the PAYE system that often results in considerable tax overpayments”.

The importance of getting advice

He says: “Once again, pension savers are being caught out by our clunky pension taxation system.

“Over the course of 2021, £142m was repaid by HMRC to pension savers, with the bulk of this in the third and fourth quarter of the year, implying that more and more pension savers are dipping into their pensions in the latter half of the year.

“This highlights the importance of getting financial advice before touching your pension. HMRC will make a repayment automatically, but this could take some time, so if you want a refund to come through more quickly, then make a repayment claim yourself to avoid waiting for HMRC.

“Working with someone who knows and understands the system and can plan your financial affairs thoroughly with you will reduce the risk of lost income being handed to the tax authorities, or if it is taken, then helping you reclaim it speedily and effectively.”

Emergency tax codes

The emergency tax code is put in place when someone makes a withdrawal from their pension because doing this in one month means HMRC will tax you as if you are taking this as regular income, says Helen Morrissey, senior pensions and retirement analyst at Hargreaves Lansdown. The result is a potentially significant overpayment if it is not caught quickly.

She says: “You can of course reclaim the extra cash, but it takes time and can come as a bit of a shock if you aren’t expecting to be taxed so much. Clients can navigate these issues themselves, but if they don’t know the problem exists to begin with then they can fall foul. Working with an adviser means they can keep an eye on these things and make sure allowances aren’t breached and that you are claiming everything you are entitled to.”

Despite the fact that the UK pension system went through what was called ‘pension simplification’ from April 6 2006, the pension system remains incredibly complex, and this is just one example of where unsuspecting pension savers can find themselves in conflict with the rules if they do not get an adviser to guide them.

More than one pensions trap

However, this is just one issue that advisers can help pension savers avoid. One of the other major issues is the amount of pension tax relief that remains unclaimed because many 40 per cent and 45 per cent taxpayers do not realise they may need to reclaim everything over the basic 20 per cent tax rebate on a self-assessment return, even if they are in a PAYE system.