The little known tax trap that is costing some pension savers thousands

The money you put into your pension qualifies for tax relief. Workplace pensions are set up either as “relief at source” or net deductions, and higher income taxpayers who have pensions set up with relief at source will end up overpaying extra tax, unless they do tax returns or separately claim a rebate.

This is because of a quirk whereby relief at source assumes nobody pays more than basic rate tax. However, those who pay higher-rate tax are entitled to claim back more on their pension contributions, because they’ve paid more. The nationally representative survey found that 13% of Brits have a relief at source pension, putting them at risk of overpaying tax. Concerningly, more than a quarter (27%) have a workplace pension but don’t know how their pension is set up.

People from both of these categories who are higher income taxpayers total almost 5% of total survey respondents, or 2.4 million Brits. Existing research showed that 76% of eligible higher income tax payers didn’t claim a pension rebate.

Another frustrating rule for taxpayers is that you can claim tax rebates relating to your pension only for the last 4 tax years. This means that there are many people who have lost, and will continue to lose, a huge amount. As an example, someone on £90,000 per year who is contributing 5% to their workplace pension (£4,500) annually for 10 years should be able to claim £11,250, yet could only claim £4,500 due to the 4 year claim cap. This means £6,750 in overpaid tax will go to the government.

The government’s PAYE tax calculator is broken, so to see if you could claim a rebate, use this pension rebate calculator here: https://www.finder.com/uk/pensions/pension-contribution-tax-relief-calculator

Tony May, 34, from London is someone who claimed a rebate. He said:

“I stumbled across this when I was looking into doing tax returns online. There was such a lack of information online about it - I found some obscure YouTube video which mentioned how to do it and researched on the HMRC site until I found the details.

“What is particularly frustrating is that I had to send a letter to sort it out and the response time was 4 months. I didn't feel like there was any transparency throughout the process.”

George Sweeney DipFA, personal finance expert at the comparison site, Finder, said: “This is a significant flaw in the pension system that amounts to the stealthiest of stealth taxes. The fact that a lot of people will have to claim money that is rightfully theirs is frustrating in itself but the process of claiming a rebate isn’t easy either. Some of our employees went through this process, but most of them weren’t able to reach anyone at HMRC on the phone so had to resort to sending a letter, and wait 3 months for a response.

“More needs to be done by the government, as well as pension providers that don’t support net deductions, to raise awareness of this. The fact you can only claim the rebate for the previous 4 tax years makes it particularly important that people find out as soon as possible and act with urgency to make sure they get back any tax they’re owed.

“To make matters worse, the official PAYE calculator is also broken with no sign of when it might be up and running again.”

To see if you could claim a rebate and for how much, use Finder’s pension rebate calculator: https://www.finder.com/uk/pensions/pension-contribution-tax-relief-calculator