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|Cashing in your small pension fund - you may be overpaying tax!|
The Low Incomes Tax Reform Group explains some of the tax aspects of cashing in small pension funds, and where it may be possible to claim a tax refund when the funds are paid out.
If you want to cash in a small pension, or several small pensions of up to £17,500 in value during the tax year to 5 April 2010, you may find that too much tax is taken off the lump sum you get. This article will explain how this happens, and what you need to do in order to reclaim the excess tax.
Cashing in your small pension fund
This article may apply to you if you are aged 60 and over but under 75 and you have a small pension fund or multiple small funds which you want to cash in. By ‘small’ we mean under £17,500 in total – this is 1% of your lifetime allowance in the 2009/10 tax year, and will increase in subsequent years in line with the lifetime allowance (£1.8 million for each year from 2010/11 until 2015/16).
The process of cashing in the benefits from a small pension, or a number of small pensions within the £17,500 limit, is known technically as ‘trivial commutation’. It is important to understand that for this to apply - your pension funds from ALL schemes when added together must not exceed the £17,500 limit.
Not all pension scheme providers allow trivial commutation so if you want to take advantage of the new rules you need to contact your insurance company and find out their policy on this.
If you cash in a small pension fund or funds, the first 25% of the lump sum will be tax free, but the remainder will be taxed under PAYE just like wages or pensions are at present. You will have up to 12 months from the date you cash in the first pension to commute up to the £17,500 limit. Bear in mind though that if you are already in receipt of pension income from other schemes, the crystallised pension rights from these schemes will be taken into account when working out whether you will have exceeded the limit.
How to reclaim tax
We now explain how you should go about claiming a tax repayment if you do cash in a small policy and you think that the tax taken off may be excessive.
When you cash in your policy, your insurance company will send you a form P45. This is the same form as you get when you leave a job. The form shows the amount of the taxable lump sum payment and the PAYE tax taken off.
If you are already receiving a pension from that particular insurance company, they will use your existing code number when they work out the tax due. But if you have not yet started to receive a pension, the company will have to use what is called an emergency code number. This makes it more likely you will have paid too much tax on the lump sum.
Normally HMRC will check your tax position at the end of the tax year and make any repayment due to you then, but if you think you have definitely paid too much tax you can claim an immediate repayment instead of waiting until after 5 April. See below if you complete self assessment tax returns.
If you have any problems getting HMRC to make an in-year repayment we would suggest you might quote their own revised manual page to them. The page is PAYE 91045 - taxpayer end of year: taxpayer overpayments: in-year repayments and trivial commutation payments. You can use the link if you want to have a look at the page yourself.
To make your claim, you will need to call your HMRC Contact Centre (the phone number will be on your notice of coding or any other correspondence you have had with HMRC) and ask them for a form P53 to complete. If you have had no contact with HMRC in the past you can find phone numbers on HMRC’s website or alternatively, in the BT phone book under HM Revenue & Customs (Inland Revenue in older editions). If you are using any other phone company you can still get details from the Yellow Pages under Government Offices.
It is important to note that form P53 can only be issued by your tax office and not by download from the HMRC website or via the Orderline.
You may find that your insurance company will write to you setting out most of the above points when they send you your form P45, but in case they do not, it is worth knowing that you may end up overpaying tax and how to go about reclaiming it.
Self assessment taxpayers - claiming an in-year repayment
For self assessment taxpayers - the option to claim an in-year repayment is available from 6 April 2009.
You can use form P53 despite the fact that the information you give will be estimated for in-year repayments. In any event, HMRC will check the position again after the end of the tax year. You should sign the declaration on the form, and return it along with forms P45 Parts 2 and 3, which are required before any repayment can be made.
You will need to return the form P53 to your main PAYE tax office which is not necessarily the office where your pension/annuity reference is held. You will also need to remember to declare that you have had an in-year refund when completing your tax return at the end of the year (a box on the return is provided to enter it).
If you are not resident in the UK, HMRC will not issue a form P53 as this does not contain enough information to enable them to deal with your claim. You should instead contact CAR - Residency on 0845 070 0040 (or from outside the UK (44) 151 210 2222).
In order to illustrate the above we have adapted two articles from HMRC manuals to explain how the new rules will work. Trivial commutation is a complicated issue so we have tried to set out each stage of the process for you to look at step by step:
Example 1 – Payment of a trivial commutation lump sum
Example 2 – No trivial commutation allowed
What if I need more help?
Older people on low incomes can contact the charity TaxHelp for Older People if they need assistance with claiming a refund. Their helpline number is 0845 601 3321 (charged at local rates from BT landlines); or, if you prefer, the geographical alternative is 01308 488066.
About The AuthorThe Low Incomes Tax Reform Group (LITRG) is an initiative of the Chartered Institute of Taxation to give a voice to those who cannot afford to pay for tax advice. LITRG comprises tax specialists from professional practice and the voluntary sector, from publishing and from HM Revenue & Customs, together with people from a welfare benefits and social policy background. Visit www.litrg.org.uk for further information.
Article Added Tuesday, 04 August 2009 | 7953 Hits
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