This piece first appeared in Saga Magazine in June 2003
The text here may not be identical to the published text

 

Crack that Code

Tax codes and tax back

TAX CODES
The Inland Revenue has a clever way to collect most of the income tax we pay. It is taken off our pay or company pension before we even see the money through what is called a ‘tax code’. And most of us just accept that the amount of tax deducted is correct. But often it is not. Tax codes are a way of collecting tax not of assessing it. They are approximate and are often wrong. The wrong code means that the wrong amount of tax is being deducted each week or month from your pay or a pension from your job. And unless you check, you will never know. There are no official figures but some accountants estimate that one in five tax codes is wrong. That would mean around five million people have too much – or too little – tax deducted from their pay or company pension.

How tax codes work
Each year, we are all allowed to have a certain amount of income before any tax is due. This is called a personal tax allowance. For people under 65 it is £4615, the same as last year. A tax code is a way of dividing this tax-free income over the whole year. For example if you are paid each month then you are allowed a twelfth of £4615, around £384, of each month’s pay or pension before any tax is due. If it was not done this way, you would pay no tax for the first few months and then for the rest of the tax year all your income would be taxed. So a tax code is a sensible idea; it spreads your tax free allowance evenly over the year. But tax codes can, and do, go wrong.

For example, most older people have a higher personal tax allowance and they went up by quite a lot this year. For those aged 65 to 74 the allowance is £6610, or £6720 if you are over 75. These higher allowances apply from 6 April before your birthday. Even if your 65th or 75th birthday is on the last day of this tax year – 5 April 2004 – you should get the higher allowance for the whole of the tax year 2003/04. But the Revenue does not give it you automatically from the start of the tax year. Instead it waits until you reach 65, then it writes to you to confirm your age and income, then it adjusts your tax code. The result is you pay too much tax in the months before your birthday and too little in the months after. If the Revenue gets its sums right, you should end up paying the correct amount of tax over the whole year. But if you do not reply – perhaps the letter goes to the wrong address or you simply forget – then your tax code is not changed and you will pay too much tax until you contact the Revenue.

The reason for this strange procedure is that the higher allowances are not given to everyone from age 65. If your annual income exceeds £18,300 in 2003/04 then the higher allowance is reduced and you do not get it at all if your income is more than £22,290 (£22,510 if you are over 75). The Revenue argues that if it gave the higher allowance automatically just on your age, some people would be paying too little tax. So it writes and waits for an answer.

If you want to pay the correct amount of tax from the start of the tax year you have to contact the Revenue to ask for your code to be adjusted. That will ensure you are paying the correct amount of tax all year – and in future.

It is not just people aged 65 or more who can be given the wrong code. If you have had a change in circumstances – such as starting or stopping work, beginning to claim a pension from your job, or if you get married or are divorced or widowed (and you or your spouse were born before 6 April 1935) then your code may be wrong. It may also be wrong if you have a source of income that is paid gross without tax being deducted or if you have paid too much or too little tax in the past and it is being adjusted by changing your code. And of course it can be wrong if you have a 65th or 75th birthday during the tax year,

Check your code
So when you get your tax code, check it carefully. Make sure you understand what each number represents and that the arithmetic is correct. Remember, the lower your tax code the more tax you pay.

The tax code consists of a number and a letter. The number is the amount of money you can have tax-free in the year with the last digit removed. So if you are under 65 and your personal tax allowance is £4615, your code will be 461L. The letter ‘L’ means you get the standard personal allowance. A ‘P’ means you get the age allowance for someone aged 65 to 74, and ‘Y’ means you get the higher age allowance for someone aged 75. Other letters are ‘V’ if you get married couple’s allowance and ‘T’ which includes just about everyone else. If you have a ‘K’ – which comes before the number – then you have a ‘negative’ tax allowance. In other words you have untaxed income which is more than your tax-free allowance and the extra tax is collected by taxing your pay or a pension from your job at more than the basic rate of tax.

If you have more than one company pension, or a pension and a job, then the code will be applied to the higher income. Your lower source of income will be taxed in full, without any tax-free allowances.

State pension
Once you start getting your state retirement pension your tax code will change and you will start paying more tax on your pay or pension from your job. The reason is that your state pension is taxable, but it is paid gross before tax is deducted. So the state pension uses up a lot of your tax-free allowance each year. For example, if your tax-free allowance is £6610 and your state pension is £4368 a year, that only leaves £2242 of other income before tax is due. In this case your tax code will be 224P. Check that the amount of state pension taken off your tax code is correct – the Department for Work and Pensions does not always give the right figure to the Inland Revenue.

TAX BACK ON SAVINGS
If you have savings in a bank or building society, tax of 20% is automatically deducted from the interest. But more than six million people over pension age should not pay tax because their income is not high enough. And almost another million should only be paying at the starting rate of 10% which this year is charged on the first £1960 of income above your personal allowance. Apart from pensioners, there are millions of children and many low earners, including many married women, who pay no tax. But under the law, banks and building societies have to deduct tax automatically at 20% from all interest payments unless you tell them that you do not pay tax. Three years ago the Inland Revenue estimated that four million people, most of them under 65, were owed £300 million in tax which had been wrongly deducted from savings interest. Much of it still has to be claimed.

If you are under 65, then you should pay no tax on your savings interest if your annual income is £4615 or less and you should only pay 10% if it is less than £6575 a year. If you are over 65 the figures are £6610 for no tax and up to £8570 a year for 10% tax. If you are over 75 they rise to £6720 and £8680.

If your income is less than these amounts and you have savings which earn interest then you can claim tax back. Get form R40 from your local Inland Revenue enquiry office. If the tax due is £50 or more you can claim it back at once. If it is less than £50, claim after the end of the tax year. You can claim over-paid tax from as far back as 1997/98. For the future, if you are due to pay no tax, then you can fill in another form R85 and get the interest paid gross, without tax being deducted. However, you cannot do that if you are due to pay tax at 10% on any of your savings interest. You will have to claim back the excess each year. More information about claiming tax back is on the Inland Revenue website or call the TaxBack helpline 0845 980 0645. A useful leaflet IR110 A guide for people with savings is available from the Inland Revenue.

Direct payments
Around five million people have their pension paid into a bank or building society account every four or 13 weeks in arrears. As I explained in Saga Magazine in April, they can now have their pension paid into the account weekly in advance. Some people have found difficulties in getting the change made and the Department for Work and Pensions has admitted there were some delays in making this new service available. Those problems should now be over. If you want to change to direct payment weekly in advance call 0845 606 0265 to get the address of your local Pension Service centre. You will then have to contact that office directly and ask for the form to complete.

June 2003


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