Millions of workers could be missing out on hundreds or even thousands of pounds in pension tax relief, with higher and additional-rate taxpayers particularly at risk if they pay into a pension scheme where tax relief is claimed at source.
The warning comes as HMRC prepares to correct a separate problem affecting low earners in so-called net pay pension schemes. But investment experts AJ Bell says higher earners should also check their pension arrangements rather than assuming they are receiving the full tax break available.
Two ways pension tax relief works
There are two main ways pension contributions can receive tax relief. Under a net pay arrangement, contributions are taken from earnings before income tax is calculated, meaning the contribution receives tax relief at the saver’s marginal rate automatically.
But under a relief at source scheme, contributions are made from take-home pay, and the pension provider then automatically claims basic-rate tax relief from HMRC. So, for every £800 paid into the pension, another £200 is normally added, making a £1,000 contribution.
Higher earners may need to claim extra relief
However, a higher-rate taxpayer is entitled to further relief. For someone paying 40% income tax, another £200 can be reclaimed from HMRC on that £1,000 contribution. Failure to claim it means the saver is effectively leaving money with the taxman.
Charlene Young, head of technical at AJ Bell, said: “HMRC is finally reaching out to lower earners to correct the net pay anomaly and there has, understandably, been a lot of focus on ensuring the lowest paid aren’t missing out on crucial pension tax perks. But they are not the only pension savers who risk being short-changed if they mistakenly assume pension tax incentives are taken care of automatically. Higher earners may need to claim tax relief too and could be missing out on thousands if they don’t.”
Who is affected and how to claim
The issue could affect far more people than some savers realise. AJ Bell points out that Nest, the UK's largest workplace pension provider, operates a relief-at-source arrangement for its 13 million members.
Workers can check their payslip or ask their employer or pension provider which type of scheme they are in. If contributions are taken before tax, the saver is generally already receiving the appropriate relief and does not need to make a separate claim. But if contributions are taken after tax, the pension is likely to operate on a relief-at-source basis.
Higher and additional-rate taxpayers may then need to contact HMRC to claim the extra relief. Those who complete a Self Assessment tax return can include their pension contributions in their return, while people who do not normally complete a tax return can make a claim directly to HMRC online or by writing to the tax authority. Claims can also be backdated by up to four years, meaning people who have failed to claim in previous tax years may be able to recover money they are owed.
Ms Young said: “Although it may feel like a faff, claiming what you’re owed could land you a rebate from the taxman worth hundreds, or even thousands of pounds.”
The warning comes as millions more people have been dragged into higher tax bands as a result of frozen income tax thresholds. This process, known as fiscal drag, means wages can rise while tax thresholds remain fixed, resulting in more people paying higher rates of tax without the headline rates actually increasing.
Nearly nine million people are expected to pay income tax at higher or additional rates during the current tax year. Ms Young said: “It’s particularly important for those people paying 40% tax for the first time to take note. That’s because they may only be receiving 20% tax relief – the basic rate – and are entitled to claim an additional 20% on top.”
She added: “If you’ve been a victim to the tax threshold freeze you’ll already be paying a higher income tax bill as a result, so make sure you aren’t unwittingly shooting yourself in the foot, stumbling into another tax trap by failing to claim back the full 40% rate of income tax on your pension contributions.”
