SAGA — Doing things properly

Tax changes on private pensions

The people affected have a pension they first paid into before July 1, 1988. They were called Retirement Annuity Contracts (RACs) or sometimes section 226 pensions and were the forerunner of the personal pensions which began that year. Generally they were paid into separately from employment. But some people will have paid in to one through their job if their employer was not large enough to run a full company pension scheme. Altogether there are about 1.2 million people drawing one of these pensions.

Until April 2007 they were taxed in a very rough and ready way. Tax at the basic rate of 22% was deducted automatically before the pension was paid. For some that meant too much was paid, for others too little. People who had no tax to pay could declare they were a non-taxpayer on a form called R89. That ensured the pension was paid in full without tax being deducted. And anyone who should have paid tax on only part of the RAC pension or paid tax at the lower rate could reclaim some of the overpaid tax which had been automatically deducted. Unfortunately around 200,000 people did not fill in form R89 or claim back the extra and have paid too much tax from the day they retired. They should now claim back the money tax that was wrongly deducted.

From April this system has changed and people on these RACs will be taxed through a tax code, just like people at work or those with a company or personal pension. The code tells the employer or pension provider how much tax, if any, to deduct and should be more accurate than the rough and ready system of deducting 22% from everyone.

Good news and bad

Some people will get good news and pay either no tax at all or less than they have been when tax was deducted at the full rate of 22%. If the tax on your RAC has gone down there is a good chance you can claim back money for previous tax years. You can claim back overpaid tax for six years to 2001/02 and interest should be paid on the money wrongly deducted. You should write to RACS, HMRC Leicester & Northants Large Processing Office, Saxon House, 1 Causeway Lane, Leicester LE1 4AE, with all the details you have about your income in those six tax years. If you cannot remember or find the relevant documents don't worry - get the claim in and sort out the details later.

For many others the news will not be so good. Some people who did register as non-taxpayers on form R89 and had no tax deducted in the past may now find that subsequent increases in their income have pushed them above the tax threshold. They may now have to pay some tax on their pension for the first time. The Revenue has said it will not claim back any unpaid tax from earlier tax years.

The advice agency Tax Help for Older People has warned that the Revenue is getting many of the new tax codes wrong. Manager Carol Pavely told Saga Magazine: "People who were zero or 10% taxpayers are being given a code as a basic rate taxpayer. Often the code does not take account of age allowance or married couple's allowance." She also said that the Revenue helpline dedicated to the change had been "totally jammed" despite having 200 staff. The Revenue admitted to Saga Magazine that the helpline was "a little busy". There are also reports of long delays in dealing with forms and letters. But the important thing is to register the claim.

The Low Incomes Tax Reform Group is pressing the Government to extend the cut-off date for claiming back tax that has been wrongly deducted. The normal limit is six tax years before the current year - meaning no tax overpaid before 2001/02 can be reclaimed. But the group points out that changes to the taxation of RACs were first promised in July 2004. Ruth Kelly, then the Treasury Minister responsible, told Parliament she would examine ways to make sure that "people are not penalised unfairly by the current system". No changes were in fact made then and LITRG does not see why pensioners should now suffer because it took nearly three years to implement the change. It wants repayments to be made back to 1998/99.

Coding errors

Although the new system should be better, tax codes are a way of collecting tax not of assessing it and often contains mistakes. A National Audit Office report in February revealed that nearly six million taxpayers - about one in five - are paying the wrong amount of tax due to errors in tax codes and that £500 million may have been overpaid in 2005/06 alone. For people whose income is fairly stable and who pay basic rate tax they are usually accurate. But for people on lower or higher rates of tax or who have an irregular income they are only approximate. If you have significant savings that earn interest the Revenue has to estimate how much that will be to work out the code. If that estimate is wrong then the tax deducted will be wrong.

From April 6 the basic tax allowance - the amount you can have in income before tax is due - is £5,225 for people under 65, £7,550 for those aged 65 to 74 and £7,690 for anyone who is more than 75. You are entitled to the higher tax-free allowances for the whole of the tax year in which you reach the appropriate age. So you should get the higher allowance for 2007/08 even if your 65th or 75th birthday is as late at April 5, 2008. But it is often not put in the code until the next tax year - sometimes not at all. Another source of error is the married couple's allowance. It is available to married couples or civil partners where at least one was born before April 6, 1935. But this "allowance" is in fact a flat-rate discount off your tax bill. Putting that in the tax code often means the wrong amount of tax is deducted.

If your total income from all sources, including your state pension and your RAC, is less than the basic allowance, then you should pay no tax on your RAC. If you are blind or if you are married and at least one of you was born before April 6, 1935, then you can have more income before tax is due. You will not get the higher allowances in full in 2007/08 if your income is more than £20,900.

People who get a pension from an old employer or a personal pension or Retirement Annuity Contract should now get a notice of coding every year, which sets out how their tax code has been worked out. Check that all the figures are correct and that the arithmetic is right. If you have any queries call the tax office named on the notice and ask for an explanation.

Even if the tax code is worked out correctly it may still result in the wrong amount of tax being deducted, if your circumstances or income change during the year. So at the end of the tax year it is important to check that you have not had too much tax deducted.

Further information

Tax Help for Older People (TOP) 0845 601 3321 www.taxvol.org.uk

Tax Aid 0845 120 3779 www.taxaid.org.uk

Low Incomes Tax Reform Group www.litrg.org.uk

HMRC Retirement Annuity Helpline 0845 366 7868

Q&A from HMRC www.hmrc.gov.uk/pensionschemes/