Heather Rogers, founder and owner of Aston Accountancy, explains what women receiving thousands of pounds in state pension arrears should tell the taxman.
If you were unfortunate enough to be underpaid your pension in the past, but have now received your backpayment, then well done.
However, what do you do now?
State pension is taxable, although no National Insurance is payable.
If you have received a large underpayment, then you may need to fill in a self-assessment tax return.
Even if you do not normally use an accountant, I strongly suggest that in this instance you do contact one – and make sure they are a qualified tax adviser.
It will be worth your while to get this right, and have a professional in your corner to fight HMRC if necessary.
If you are already registered for self-assessment and have a tax adviser, then you should let them know about your backpayment.
If you usually file your own return online, I still suggest you take expert advice, even if only as a one-off.
The first question you will want to ask your tax adviser is of course ‘how much tax do I have to pay on this payment?’
Well, there is the potential problem. If you receive a large amount of backdated pension this could, if treated in full as income in the year you receive it, be taxed at a higher rate than if you had got it in the year it should have been paid.
This seems hardly fair, especially if no tax would have been payable if the right pension had been received at the time.
Depending on the amount of political pressure applied via parliament, there may be an argument for not taxing these payments at all, but people should certainly not bank on that outcome.
We will have to see what view HMRC takes, and test cases may be the way forward. But in my opinion, one of the following scenarios will apply.
A. The backdated pension should be allocated to the tax year to which it applied had it been correctly paid and your tax position for the affected year(s) should be re-assessed in-house by HMRC.
If an adjustment to your tax position is required for that year, HMRC can issue a revised calculation and if necessary a tax demand for each year affected.
There is a rule that assessments can only go back four years, but in my view this time limit won’t apply because this is not an enquiry, or a failure to disclose.
It is a taxable backpayment, which was not known about by either the taxpayer or HMRC, which is now being paid to the pensioner. The disclosure might even be out of limits.
B. The backdated pension should be treated in the same way as state pension lump sum payments.
This is where people have opted to defer their state pension for several years, and been paid a lump sum. For people who have reached state pension age since April 2016, the deferment rules have changed and you can only receive an enhanced income, not a lump sum.
However, for those who are old enough to still qualify for lump sums, the pension was deemed to be taxable when the taxpayer chose to take the sum, not when it was actually paid to them.
Interest is payable to the recipient for deferring a state pension, as the government has been in possession of your money for its own use during that time.
In these circumstances, the amount of tax due on it was calculated by taking the total of your other income for that tax year and applying that rate of tax to your pension lump sum. So effectively, it was ignored when adding up your income.
If you had no tax liability on your other income, neither did your pension lump sum, or if your income fell into the basic tax bracket income, currently between £12,500 and £50,000 (20 per cent tax rate), so did your pension lump sum.
This means you only paid tax on what effectively you would have paid if you had taken the pension at the time.
What will HMRC do about these backpayments?
HMRC should resolve the issue with you, especially if you either file a tax return, but even if you don’t, if you currently are in receipt of private pension income or employment income where you receive a P60.
HMRC will have copies, and therefore will be able to compute your tax underpayment.
However, I still urge you to take expert advice.
Ultimately, if HMRC does try to tax the payments as though they were received in full in the year they are paid, then you might be able to challenge this at the First Tier Tribunal.
This is where taxpayers can challenge decisions made by HMRC. Often the decision will be different from that of the officer in charge of the case.
I have found this a significant benefit in my professional life when taking on HMRC on behalf of clients. The First Tier Tribunal decisions are published, helping others in many cases.
What should women who are affected by this do now?
– Check your pension with the DWP if you are worried you have been underpaid. The DWP does not seem pro-active on this at all. It only seems to respond when challenged.
– Get in touch with an accountant if you receive a backpayment, and make sure they are a qualified tax adviser. Do not expect HMRC to sort the matter out for you; it should do, but there is no guarantee.
– Make an official complaint, especially if the DWP has not included interest in your backpayment and the claim goes back several years.
– If you think someone received the wrong amount of pension in their lifetime and they are no longer with us, then you can also complain. You you may wish to contact both the DWP and HMRC.
Give them the deceased person’s National Insurance number, and/or as much information as you have about their state pension, and ask them to investigate.
– Get in touch with your MP and make a fuss! That’s what they are here for. Also, the stories of underpaid pensioners will feed their way into parliament and help to boost support for those affected.