HM Revenue & Customs is not grasping the level of taxpayer confusion surrounding the tapered annual allowance, according to Steve Webb.
The rules which reduce pension tax relief limits for higher earners are causing confusion for taxpayers which HMRC does not understand, the former pensions minister and director of policy at Royal London said.
Sir Steve wrote to HMRC on June 18 about the position of higher earners who are members of defined benefit pension schemes.
The tax authority replied saying it was down to the taxpayer to ensure they had paid the correct amount of tax on their pensions.
Under current rules, where a member of a scheme builds up funds in excess of the annual allowance, which is currently £40,000, the scheme has a duty to inform the member of this fact.
This information can then be included in the member’s tax return.
But higher earners may be caught out by the tapered annual allowance whereby their allowance is reduced below £40,000 because their total taxable income, including the growth in their pension rights, exceeds £150,000 in a given year.
The tapered annual allowance means that for every £2 of adjusted income above £150,000 a year, £1 of annual allowance will be lost.
For these people they may have an annual allowance anywhere between £10,000 and £40,000.
Since their DB scheme cannot possibly know the annual allowance that applies to such individuals, the scheme will not notify them if they exceed their annual allowance, explained Sir Steve.
For example, if someone has a personal annual allowance of £25,000 and accrues £30,000 in DB rights, they will be over their limit but the DB scheme will be unaware of this.
Sir Steve wrote to HMRC to ask about such situations and how individual scheme members were expected to give the right information on their tax return if they get no information from their DB scheme.
In its reply, HMRC said the number of people accruing more than £40,000 was relatively small and the duty was on an individual to comply with the law and make accurate declarations on their tax return.
The tax authority stated: “It is an individual’s responsibility to make sure they have declared their income correctly.
“Pension scheme administrators are required to provide a scheme member with details of their annual pension savings where these exceed the standard annual allowance, or where they have reason to believe the member has flexibly accessed their pension rights and their pension savings exceed the money purchase annual allowance.
“Individuals can use this information to calculate their tax liability on their pension benefits income and submit or amend their tax return.
“We expect individuals to fulfil their obligations and, where we find someone has underpaid tax, we will seek to recover unpaid amounts due.”
In response to HMRC’s letter, Sir Steve said: “HMRC clearly live in a parallel universe where taxpayers perfectly understand the tapered annual allowance and the way that DB accruals are tested against it. A system designed for a world where everyone faces the same £40,000 annual allowance simply does not work in a world where different people have different annual allowances.