HM Revenue and Customs is changing the way retirement annuity contracts are taxed as around 200,000 pensioners are paying too much tax.
From April 2007, all income from RACs, except purchased life annuities, will be classed as pension income and taxed under the Pay As You Earn (PAYE) system in the same way as personal and occupational pensions.
At the moment, unless the annuitant has completed a form confirming they are exempt from tax annuity providers deduct the basic rate of tax at 22% from the RACs at source, which HMRC says means some pensioners pay too much.
It says there are around 1.2 million individuals receiving income from RACs, with about half of these claiming tax exemption and receiving their payments gross.
However, it points out the remainder have tax deducted at the basic rate, which for basic rate and higher rate taxpayers is not a problem, but it says for those who shouldn’t be paying tax - ie those only liable for the 10% starting rate - or who should only have tax deducted from part of their annuity, the current rules mean they are all overpaying.
So HMRC is creating a new PAYE scheme for every RACs provider and is in the process of setting up new tax records for all of the annuitants not currently on its database. This has involved writing to around 350,000 people to ask for details to help make sure they pay the right amount of tax in future.
For those who have overpaid already, HMRC says many pensioners have never made a claim as they may not have realise tax had been deducted, while it says the “complicated and time consuming” process of form-filling may have put people off.
HMRC also claims the new PAYE process will help HMRC identify the pensioners who have overpaid and will allow it to make a renewed effort to help them claim and receive their repayments.
Having decided to make the changes HMRC will also be contacting up to 275,000 annuitants in January who had previously filled in tax exemption form R89 to let them know from April they may have to start paying tax if their circumstances have changed.
But it says it will not pursue any tax arrears incurred by annuitants who should have paid tax before April 2007 except in “very serious cases where we find false statements or returns have been made to deliberately avoid paying their tax”.
HMRC says in February it will be sending every annuitant a 'notice of coding' form explaining how their PAYE code has been worked out, although it admits some members could receive up to 15 different letters from HMRC because providers may have sold their “annuity books”.
It points out these sales can complicate the setting up process for the new system, particularly as it is aware of several large “annuity book” transfers taking place in the run-up to the switch to PAYE in April, as some providers want a tax code for every annuity they pay even if it is to the same person, as they may have multiple annuities.
HMRC says this “will result in some annuitants getting conflicting information about who is paying for their annuity”, and although it says it is working with providers to minimise the problem it points out “we cannot cover every eventuality”.
Andrew Tully, marketing technical manager at Standard Life, says it makes sense for RACs to be paid and taxed in the exactly the same way as other pensions.
But he adds: “It is very important people who have been paying basic rate tax on their pension, but should have been paying a lower rate or not at all, act quickly to get their overpaid tax back. People have five years from 31st January after the end of the relevant tax year in which to claim, otherwise it won’t be possible to get their money back.“
If you have any comments you would like to add to this story or would like to speak to its author about a similar subject, telephone Nyree Stewart on 020 7968 4558 or email [email protected]IFAonline
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