By Ahmed Bawa, CEO, Rosemount Financial Solutions (IFA)
HM Revenue & Customs has a pension problem. Every quarter new figures are published by the Government covering the amount of overpaid tax on pensions that have had to be repaid to savers, and they are eye-watering sums of cash.
In the first quarter of this year for example more than £42 million had to be handed back, while over the tax year as a whole an extraordinary £198 million was repaid. That’s a new record.
However, this issue provides an opportunity for advisers to not only educate their clients, but also strengthen the relationship they enjoy with them.
The taxman’s calculations
The problem dates back to the introduction of the pension freedoms by the Coalition Government. When the pension saver makes their first withdrawal, they often opt for a single lump sum. However, HMRC bases its tax calculation as if this will be a regular income, rather than an enlarged one off, meaning that significant numbers of pension savers end up paying far more tax on that withdrawal than they really should.
This process then leaves the savers in a difficult position. First and foremost they will have less to show for it, having made that withdrawal, given the taxman has helped themselves to a large portion. There could be resulting problems here, for example if the saver was hoping to use a specific sum, perhaps to cover the cost of home renovations or to gift to a loved one to use as a deposit on a property.
There is then the issue of reclaiming that overpaid tax. The saver can wait until the end of the tax year, at which point HMRC should acknowledge its mistake and issue an automatic refund. That’s all well and good if the first withdrawal is made in the first few months of the calendar year, so the saver only has a relatively short period to wait. However, if they make that first withdrawal over the summer, for example, then that’s an awfully long time in which they are effectively lending money to HMRC, money which they could no doubt put to better use themselves.
If they want to get that money back more quickly, they instead have to go through the rigmarole of manually claiming it, a process which is not exactly renowned for being speedy.
Supporting pension savers
It’s clearly ridiculous that we are still in this situation. The pension freedoms were introduced more than a decade ago, so you would have thought at some point the powers that be would have worked out a way around this calculating challenge. Yet here we are, with the burden falling on pension savers and their advisers to go through the rigmarole of having to claim the overpaid tax back
Thankfully there are strategies that can be employed which offer a route around these enormous tax bills. For example, some advisers have recognised that making a modest initial withdrawal – say £100 – means that the taxman will not base its calculations on a one-off, large withdrawal and so the client will not be liable to such significant tax bills.
Strengthening relationships
This is where advisers can really demonstrate the value they add to their clients, educating them not only on the dangers of being hit with such a substantial emergency tax bill, but also the ways around the issue.
Given HMRC shows little inclination towards actually addressing this issue, it comes down to advisers and their clients to be smart in sidestepping it. Yet most clients would have no idea of how to do so without the insight of their advisers.
It’s a great example of the service financial advisers provide in helping clients build wealth for the long term – it’s not just about pinpointing specific products, but providing a helping hand in navigating the challenges along the way which can dent their financial position.
After all, if your adviser is able to not only forewarn you about a peculiar habit of the taxman, but also steer you around it, aren’t you then not only more likely to continue to use that adviser yourself, but also recommend them to family and friends?
The best advisers move beyond a purely transactional relationship with their clients, recognising that every opportunity for a dialogue with the client, to educate them about something, is also an opportunity to strengthen that relationship.
