The public’s lack of understanding about pensions taxation could be addressed by reverting to the old way of working with providers.
Last week the office of tax simplification (OTS) issued a report on the simplification of savings income. One section focused on the taxation of pension lump sums, particularly with regards to the use of emergency tax codes.
The report said the public did not understand the way their pensions would be taxed, which was resulting in issues.
This is not new. I cannot really believe the government would not have already thought about this when the changes were implemented.
I do have sympathy for those who have to claim back overpaid tax. But what would the cost be to the Treasury if it had to chase pensioners for underpaid tax? There would also be uproar in the national press about people being asked to pay their hard-earned pensions back to the government.
Multiple schools of thought on the issue are referred to by the OTS. The first line of thinking is chasing pensioners is the correct thing to do to avoid unexpected tax bills for those on low incomes. If they received a surprise tax bill, they would struggle to pay it back.
The line of thought is all pensions and lump sums should initially be taxed at basic rate, with higher-rate taxpayers subsequently getting a bill if needed.
The OTS does not give an opinion on what the correct way forward should be. But it does suggest the current process needs reviewing, generally because too much tax is deducted.
It is looking to work with HM Revenue & Customs (HMRC) on the process to make it fairer. Still, it believes better understanding by consumers would mean a better outcome for all.
Statistics published in the pension scheme newsletters do show that significant tax is repaid. From 1 January 2018 to 31 March 2018 the total value repaid was £22,514,839 (Pension Schemes Newsletter 98). There will be many more who just do not claim; instead, they wait for the tax year end and a rebate after that.
This is all really to do with single payments. It is not really an issue if the consumer takes a regular income, or even a few regular payments, because the pay-as-you-earn (PAYE) system will sort out the tax.
I have often pondered what would be the best way to deal with this, avoiding large tax payments upfront or large tax bills at the end of the year.
I tend to come back to the old way of working. In most cases, a provider would start the payments with a BR tax code.
This meant it would be all taxed at basic rate, unless they were aware the consumer was a higher-rate tax payer and they could apply an HR tax code to ensure the whole payment was taxed accordingly.
The tax was still sorted out throughout the year using the PAYE system, or the consumer could reclaim overpaid tax at the end of the tax year. It generally worked pretty well. People knew if they lied about their tax status, it would not be long until they were found out. In the end the tax would be recouped, one way or another.
This still seems to make sense now, even with the option to draw the whole fund out in a single payment. And it means some responsibility is put on those receiving the pension payment to disclose their tax status to the provider.
Overall I think this could work better. Education is important, and those taking these payments need to understand the implications.
Those with advisers should not be surprised. But how we get the information to those without professional help remains a challenge.
Claire Trott is head of pensions strategy at Technical Connection.