Contribution: Just a mistake or a genuine error?
The fact that pensions benefit from a number of tax privileges means the rules surrounding adding and removing funds are awfully strict. Unfortunately, those limits can sometimes be breached simply by mistakes being made. After all, we are human.
Most will make a contribution to their pension not expecting to see those funds again until they retire. The basic principle is once a contribution has been made, it cannot be removed until retirement, in ill health or death. There are very limited circumstances when a pension scheme can make exceptions to those rules. In this article I’m going to explore what those are.
If a pension scheme did allow a refund of a contribution that didn’t fit within HMRC guidelines, a significant risk is that HMRC could challenge that decision. Potentially the client could then incur an unauthorised payment, resulting in hefty tax charges (plus interest) based on the value of the refund.
The limited circumstances when a refund can be granted are as follows:
- genuine error
- cancellation period
- excess contribution
The concept of a ‘genuine error’ comes from HMRC guidance rather than legislation. That guidance doesn’t set the parameters for a genuine error where everyone might expect them to be. For that reason it can be very difficult for advisers and clients alike to know whether an error is ‘genuine’ in the eyes of HMRC or not.
The key point here is intent. HMRC does appreciate that in the day-to-day running of a pension scheme, payments may be made where in fact there is no real intention for them to be paid into a pension. The genuine error rules don’t usually cover ignorance or a misunderstanding of the rules.
Generally speaking, if the client’s precise intentions are not carried out correctly resulting in an unintended administrative failure taking place, then there is potential to receive a contribution refund providing the error is rectified as soon as possible. As the guidance is nothing more than that, some pension scheme administrators may interpret what constitutes a ‘genuine error’ more generously than others, but remember the member could end up with substantial tax charges if HMRC does decide to challenge the administrator’s decision.
Examples of a genuine error:
- employer doesn’t cancel or amend direct debit correctly
- failure to carry out client’s instructions from an adviser, bank or scheme administrator
- a contribution is sent for the wrong client
There isn’t a definitive list of errors, most refunds are looked at on a case-by-case basis to appreciate the full circumstances. HMRC published clarification of its guidance specifically related to errors made by financial advisers in its May 2018 Newsletter. It focuses on the existence of an authority for the adviser to act on behalf of the client and the clarity of instruction from them to the adviser – which isn’t then acted upon – and is worth a read.
If the pension scheme has been set up recently and the member is within their cancellation period (typically 30 days for pensions), then they can still exercise their right to cancel. This effectively reverses the whole application and any contributions made. This can be a lifesaver in avoiding an unnecessary tax headache.
A refund can be made in relation to personal, but not employer, contributions where the member has exceeded their UK relevant earnings. This may be pertinent for those who have flexible earnings, such as self-employed members, as it can be very difficult to accurately calculate those earnings in advance, for example if the member overestimates trading profits for the year. This means they may end up contributing more money than they have earned.
‘Excess’ here means the member is not entitled to the tax relief for some or all of that contribution and that tax relief must be returned to HMRC. It’s the scheme administrator’s decision whether the net personal contribution is returned to the member or left in the scheme.
Simply exceeding one of the annual allowances (annual, money purchase or tapered allowance) is not a valid reason for a refund. If a member does exceed the annual allowance it may be possible to pay the tax charge through the pension scheme via scheme pays or voluntary scheme pays depending on the circumstances. It’s worth noting that the tax charge is not as penal as an unauthorised payment charge, but instead cancels out the tax relief the member has already received.
Given that the circumstances in which contributions can be refunded are fairly limited, it’s worth remembering that prevention is better than cure. Mistakes can happen but typically an advised client will be well placed to avoid potential issues and understand whether it’s possible to fix them should they occur.