40% taxpayers urged to claim pension perk as HMRC acts on net pay anomaly

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.

Most employees will be saving into a pension by default thanks to auto-enrolment, with many people assuming that they’re getting the full tax relief they’re entitled to and that this is all handled by their pension provider, or their employer. While that’s the case for a lot of people, it isn’t true for everyone. And, 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.

Here’s how to check your pension arrangements and ensure you’re not missing out on what you’re owed.

Pension tax relief

A pension acts as a tax deferral tool. Your own contributions today are free from income tax. Assets held in your pension are shielded from income tax and capital gains tax until you come to access the funds. In retirement, you can withdraw up to 25% of the value as tax-free cash (and you don’t need to withdraw this all in one go unless you need to), with other withdrawals classed as taxable income and taxed at your marginal rate, just like your salary in your working like.

That deferral should act as an incentive, since most people will have a lower income, and therefore less of a tax liability, when they’re retired. There are two ways schemes can be set up to claim tax relief on personal contributions. Under a net pay arrangement, the employee’s pension contribution is deducted from their pay before income tax is calculated and deducted. Under relief at source, the employee pays their contributions from take home pay, and the pension provider claims 20% tax relief from HMRC to add to the pension pot.

To get £1,000 in a pension under a net pay scheme, £1,000 would be deducted from earnings before income tax. The deduction before income tax means that tax relief has been applied at the correct marginal rate, since the money is paid in before tax is ever deducted. For example, someone earning £60,000, over the higher rate tax threshold, would benefit from 40% tax relief.

Under relief at source pensions, £800 would be paid from earnings after tax and automatically topped up by £200 to a total of £1,000 in the scheme. But someone earning £60,000 would have paid more than 20% basic rate tax on that £1,000 slice of income. To benefit from full income tax relief on the contribution, they’d need to reclaim a further £200 (20%) from HMRC directly to put them in the same position as someone in a net pay scheme.

What this means is, if your employer offers a ‘relief at source’ pension scheme or you’re paying into a private pension yourself (for example a SIPP), then you must claim any tax relief owed to your above the 20% basic rate. Failing to do so means you lose out on money you’re entitled to.

Don’t assume these types of pensions are a rarity either – lots of workplace pensions operate this way. The UK’s largest workplace pension provider, Nest pensions, for instance, operates as a relief at source scheme for its 13 million members. Crucially, you can also backdate a claim. If you’ve forgotten to claim, or didn’t realise you were able to, you can backdate a claim up to four years.

How to claim

Claiming pension tax relief may sound like a pain but it could net you thousands of pounds. To start with, the best thing to do is find a payslip. That should show your NI number and any contributions made to your pension.

Firstly, find out what type of scheme you’re in. Your employer or pension provider can tell you this, or you can check your payslip. In a ‘net pay’ scheme, you’ll pay your pension contribution before any tax is paid. Your payslip will show that your taxable pay drops by the exact amount of your pension contribution before tax is calculated. In this case, income tax won’t have been deducted prior to the money being paid into a pension, meaning you’re already getting the full rate of relief and don’t need to claim.

But if your pension contributions are deducted after tax has been taken, this indicates a ‘relief at source’ scheme. The pension scheme will automatically claim back 20% basic rate relief, but you must then claim any additional relief yourself. If you’re struggling to figure things out, ask your employer or pension provider what kind of scheme you’re in.

Once you’ve established you’re in a relief at source scheme, if you’re higher or additional rate taxpayer you should be able to claim the additional tax relief owed to you. To claim you’ll need to contact HMRC directly and there are a few different ways in which you can do this. If you complete a tax return, you can include the information there and recover any tax relief owed.

If you don’t usually have to complete a tax return, you can claim the extra relief directly online from HMRC. You can also write to them, although it will take longer to process. You’ll need to login to your government gateway account. The online service from HMRC will then take you through a series of steps to confirm which tax year the claim applies to, as well as details about your employer, your payroll number and the contribution made to your pension.

Most of this should be on your payslips or your p60, the end of year summary of your taxes. You’ll then be asked to upload some documents to evidence your claim, like a copy of your payslip or a record of your pension contributions from your pension provider. Once the claim is processed you’ll either get that extra relief through your tax code adjustment, a tax refund, or an adjustment to your tax bill for the year. Paying less tax, or even getting a cheque from HMRC, could be a great boost for your finances.

Fiscal drag effect

Frozen tax thresholds and rising wages have dragged millions of people into a higher tax bracket over the last few years, with nearly 9 million people due to pay income tax at the higher or additional rates this tax year. 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.

Fiscal drag is how governments can raise more tax without actually increasing the headline rate of taxation. 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.