RP case studies: Refund of excess contributions lump sum explained

Jessica List looks at a refund of excess contributions lump sum case study in her latest article for Retirement Planner

The Situation

Eloise is 39 and earned £35,000 a year as a manager in a small factory manufacturing furniture. Her grandmother passed away in January 2020, leaving Eloise £75,000 which she received at the beginning of March.

Eloise only began saving into a pension a few years ago when she was auto-enrolled for the first time with a previous employer. She hadn’t really given retirement saving much thought before then, but read a little about pensions at the time to understand what she was saving into. Eloise learned enough to know that she would probably need to contribute more than the auto-enrolment minimum in the future in order to save enough for her retirement. However, at that time she was prioritising saving for a house deposit and didn’t have enough money spare to increase her contributions.

Eloise bought her house last year but still hadn’t got around to increasing her pension contributions, although the factory paid a little more than the minimum required under auto-enrolment. When she received the money from her grandmother, Eloise decided she would like to pay most of it into her pension.

She remembered reading that the most a person can contribute each year while claiming tax relief is based on their earnings for the year. Eloise also remembered reading about the annual allowance, but a quick check showed her that the annual allowance is higher than her earnings, so she didn’t really need to worry about it. She decided that in order to make the most of the tax relief available, she would make two contributions to her pension from the inherited money: one payment before 6 April 2020 for the 2019/20 tax year, and one after that for 2020/21.

In mid-March Eloise worked out how much her auto-enrolment contributions would total for the 2019/20 year, then called her provider and arranged to make a one-off contribution to make up the difference, allowing for the fact that the provider would reclaim tax relief on the amount she sent to them. In early April, at the beginning of the new tax year, Eloise arranged a second payment.

Only a couple of weeks later Eloise was furloughed; she was told that a lot of the factory’s customers were hotels and restaurants, and demand had plummeted due to the lockdown. In mid-May, Eloise was informed that the factory was closing permanently and she was being made redundant. With the remaining funds from her inheritance Eloise wasn’t too worried about money while she looked for a new job. Her local village shop was shorthanded, and Eloise decided to take a temporary position with them while looking for her next permanent role.

Eloise realises that there’s a good chance that the contribution she made in April will now turn out to be above her earnings for the year. She spent a few weeks on furlough, which gave her lower pay than normal as she earned over the maximum £2,500 a month and her company did not make up the difference. The village shop pays significantly less, and at this point, Eloise does not know when she will find a new job or what the salary will be – although she doubts it will be significantly more than her salary from the factory.

Eloise calls her provider to inform them what’s happened and ask if there’s anything she’ll need to do.

Her provider confirms that once Eloise knows whether the contribution is in excess of her earnings, and by how much, she will need to inform them so they can arrange for the tax relief to be returned to HM Revenue & Customs.

She will then have two choices. Eloise can opt to leave all of the remaining funds in her pension, which in effect will mean that part of the money has been paid in as a gross contribution, as it has not benefited from the corresponding tax relief.

Alternatively, Eloise can opt to receive a ‘refund of excess contributions lump sum’. The provider explains that this type of payment is only available for personal (or third party) contributions which turn out not to qualify for tax relief because they are over the scheme member’s relevant earnings: they aren’t available in respect of employer contributions, nor where someone has only exceeded their annual allowance. Eloise would need to confirm the value on which she was entitled to tax relief for the year so that the provider could return only the excess amount.

The results

Eloise can’t act immediately, as she doesn’t yet know exactly what the rest of the year will bring in terms of income.

Assuming that her income overall will be lower for the year, Eloise thinks she will most likely opt to receive a refund of excess contributions lump sum, which would allow her the option to contribute more again in a later tax year when she will once again qualify for tax relief.