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What happens if you pay more than your earned income into a pension scheme?

What happens if you pay more than your earned...

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Can anyone tell me what happens if you pay more than your earned income into a pension scheme? Obviously you would not then be entitled to tax relief on the excess payments, but do you have to inform the scheme of this? 

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By zebaa
28th Sep 2013 16:21

see here

http://www.hmrc.gov.uk/pensionschemes/tax-basics.htm

This is the HMRC site and this link should provide an overview. In a nut-shell, you can pay in whatever you want but tax relief is limited to your yearly income or £3600 whichever is higher.

Some pension funds give a 20% tax credit. If you are not due this then you must tell the fund.

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By Duhamel
28th Sep 2013 20:13

Annual allowance charge
Sounds like your question was about the admin side, but just to add to zebaa's answer- relief is also restricted if it exceeds 50k in a year, subject to conditions.

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By Emsiharris
28th Sep 2013 21:15

Thanks for your answers. I was really asking about the admin side. I appreciate that you only get relief equivalent to your earnings but I have a client who is paying in more than his salary (he takes most of his salary as dividends) so I was just wondering if he has an obligation to inform his pension scheme of the excess or if they get that information directly from HMR&C? 

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Replying to Gone Sailing:
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By kiwilondon99
29th Sep 2013 11:20

individual v company contribution

 

Emsiharris :quote -  but I have a client who is paying in more than his salary (he takes most of his salary as dividends

 

if he is receiving £7k salary and rest as divs from -presumably - his company - then the Company should be making deductible pension payments not the Director personally

could he be using up prior year unused....contribution

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By Emsiharris
29th Sep 2013 11:44

Actually the company is also making contributions but as he is a connected Director this has to be done with some caution i.e. to quote HMR&C “in line with a contribution that would have been made for an unconnected employee in a similar situation.” So, I thought it best for the company to match his personal contributions. 

I don't think you can use prior year allowance on the contributing only up to your earned wages part - pretty sure that only applies to the 50k annual limit. Maybe I am wrong on that?

I'm still confused as to whether he has any kind of obligation to inform his pension provider that they shouldn't be claiming tax relief from HMR&C on part of his contributions. Can anybody help me with that? 

 

 

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By zebaa
29th Sep 2013 15:19

See my earlier answer

From paragraph 2:

Some pension funds give a 20% tax credit. If you are not due this then you must tell the fund.

Further detail:

If the contributor does not tell the pension provider then when HMRC catch up - which could be years later - they could hand him a tax charge, which may have the usual add-ons. It depends on his & your attitude to risk, but disclosure is the correct way.

 

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By Marion Hayes
29th Sep 2013 16:41

When did this start?

There used to be two kinds of scheme

Retirement Annuity schemes allowed you to pay as much as you like into a scheme, but any fund earned by the excess contributions was classed as unearned income when the pension became payable.

Then personal pension schemes came into play as well. They did not allow payment of a premium higher than the relievable amount and I saw more than one example of HMRC instructing a fund to return excess premiums. I was also required each year to provide proof by the scheme that my premium was within limits by producing P60's any time the contribution was varied.

Now that you only put the allowable amount on a return I am not sure how HMRC would police a refund if there is a physical limit which I thought came back in a few years ago

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By Emsiharris
30th Sep 2013 08:13

Thank you - that really helps. It is not something I've really thought much about before but I can see that it could lead to big problems later on if the right advice is not given when the contributions start. 

Thanks again and have a good week!

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By gbuckell
30th Sep 2013 10:31

Caution? HMRC wool!

There is nothing to stop a company paying a large contribution on behalf of an employee who gets minimal salary. Corporation tax relief is due as long as the package of salary plus pension is reasonable given the work done. HMRC cannot dictate the split of the package. They did suggest this in draft guidance issued pre A day but backtracked after the howls of protest.

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By pjones
30th Sep 2013 13:49

Refund of contributions

I understand that some schemes will refund excess contributions however failing that, the excess should be reported on your self-assessment tax return.

This situation can of course be fairly common for self-employed people who's profits may fluctuate year on year and it is not until after the year end that they actually know their Net Relevant Earnings and therefore the amount they could have contributed during the year.

In the first instance I would suggest that the individual speaks to the pension provider and informs them of the excess contributions made.  If these are not repaid then they should report on their tax return.

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By Ken of Chester le Street
02nd Oct 2013 14:28

More than one employer

Unless I have missed something your querist doesn't say whether this is the client's only employment within the fiscal year. I don't think the relievable contribution is limited ot one employment, if the client gets £7200 from one and gets £10000 from another he can presumabley put in £7200+ the tax credit, = £9000, even if the £10,000 employment ceases before  the end of the fiscal year.

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By Paul Soper
02nd Oct 2013 16:06

Relief

You have to distinguish between contributions paid by an employee or director or self employed person and those made into their fund by an employer where the have one.

As noted above you also have to distinguish between schemes that give basic rate relief at source and those that do not.

A retirement annuity is one where tax relief can only be given by a claim and the claim cannot exceed the relevant income for the year regardless of the number of sources.  An employer can also pay into such a scheme directly and that is not subject to a limit by reference to the employees income - instead the question is, as identified, whether it is wholly and exclusively for the purpose of the trade.  However like other forms of pension provision it is subject to the annual allowance limit of (currently) £50,000, if the total of the contributions paid by both the employer and the employee exceed this figure then there will be a sopecial tax charge, the annual allowance charge, as for any other type of pension arrangement.  These arrangements are confined to older policies taken out before 1988.

Net pay arrangements are a registered form of scheme where the employee contributes a set sum where relief is given by deduction before PAYE is applied - the relief cannot exceed the amount of the income from that employment.  Again the employer will also contribute and this usually matches the employee contribution, it can, and with older schemes often does, exceed the employee contribution.  It is unlikely in an extreme that the relief for the employer would be challenged.

Top Hat schemes describe contributions which are more 'one-off' in nature paid by an employer into a scheme, they are, like the net pay arrangement subject to the annual allowance charge mentioned above.  Schemes to give benefits to family members became common to get round the £50,000 limit but this loophole was closed in this year's budget.

Where tax relief is given at source - personal pensions and stakeholder pensions every person, even if not a taxpayer can claim relief up to a gross sum of £3,600 pa. This applied whether they have income or not.

If a larger contribution is made then the employee director will have had relief at source on the premium paid but may have insufficient income to create a liability at least equal to this sum which is where the question comes in.  Tax relief is given by extending the basic rate, as for gift aid and the effect of insufficient income is to create a liability on the excess.

It is possible for the person concerned to avoid this by requesting the pension provider to refund the excess contribution, this limits the relief and avoids the clawback of the excess.  It is not the revenue that force this to happen.  Where such a refund is made it is taxed at the basic rate thus reducing the relief given on the original contribution.

Again these contributions are also subject to the annual allowance charge above £50,000 and it is here where the taxpayer can carry forward from the previous three years to increase the effective annual limit if they were in the earlier year a member of a registered scheme.

Hope this helps...

 

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By Alfie Bet
02nd Oct 2013 17:06

You may find this place useful

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By Emsiharris
04th Oct 2013 08:05

It does. Thank you! 

It does. Thank you! 

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By garethgreen
27th Mar 2014 11:02

consequences after contribution made

May I ask a follow up question on this topic? The discussion has been about the effect on tax relief for the contribution, but what about the tax consequences in subsequent years?

Am I right in thinking that if an individual makes a contribution that is higher than the amount on which relief is given, the subsequent investment returns on the excess contribution are still in the pension wrapper, so they are tax-free? Thus, if the individual would have paid 40% tax on those gains if they had been outside a tax-wrapper, 40% relief is effectively being given on the investment returns?

And what happens at retirement when the pension is drawn? Part of this is just a return of the original contribution, on which there was no tax relief. But am I right in thinking that it is, nevertheless, taxed when it is drawn? (This might negate the benefit of the higher rate relief on the investment returns.)

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