Pension savers have been overcharged more than £1bn in tax by HMRC on pension withdrawals they’ve made since 2015, according to latest figures.
Hundreds of thousands of pensioners have received an average of more than £3,000 in overpaid tax since the introduction of pension freedoms in 2015, which enables people to do as they wish with their defined contribution pension savings from age 55 (rising to 57 in 2028).
They had been subject to an incorrect ‘emergency pension tax’ code by HMRC on pension withdrawals, instead of their normal income tax rate, which is a higher tax rate than should be charged. This assumes that the same amount will be withdrawn from the pension each month, when most people take a variable income from their pot. Read more in our article What is pension drawdown and how does it work?
A spokesman for HMRC said: “Nobody overpays tax as a result of taking advantage of pension flexibility. We will automatically repay anyone who pays too much because they are on an emergency tax code. Individuals can claim back any overpayment earlier if they wish.”
Those affected need to claim back the amount overcharged themselves, instead of receiving this automatically.
Sir Steve Webb, a former pensions minister and partner at LC&P, said: “This is an absolute disgrace. A system based on systematic over-taxing of pension savers cannot be right.
“There is no good reason why citizens who access their pension should have to go through the hassle of claiming back excess taxation which they should never have to pay in the first place. Reform of the system is long overdue so that it works to the benefit of pension savers and not the Treasury.”
The majority of retirees choose to keep their pension invested in a flexible drawdown plan in retirement, which enables them to withdraw a variable income when needed. When they first make a withdrawal, an emergency tax rate is charged, which could see them pay thousands of more in tax than they are liable for. In order to claim a refund within 30 days, they must then complete an HMRC form.
If pensioners don’t reclaim the money themselves, they must rely on HMRC realising that there’s been an overpayment during, for example, the self-assessment process, and then returning the money. This could mean months pass before money owed is returned, making life difficult for those whose finances are already stretched.
Andrew Tully, technical director at pensions firm Canada Life, said: “A good tip for those customers making a pension withdrawal for the first time, is to initiate a small withdrawal of say £100. That will generate a tax code from HMRC which the pension provider will apply to any subsequent withdrawals.
“That will result in the tax being taken at source being far more accurate in many more cases, not only reducing the burden of paperwork but equally importantly the customer receiving a more accurate withdrawal in the first place.”
How to claim back tax overpayments on pension withdrawals
The exact form you should fill in to claim back tax overpayments will depend on your particular circumstances.
For example, you must complete HMRC form P53Z if you’ve withdrawn all your money from your pension and you’re still working or in receipt of benefits. However, if you have withdrawn all your pension savings but you’re not working or in receipt of benefits, you should complete form P50Z. If you’ve made partial withdrawals, you should use form P55. You can find the relevant forms here.
If you’re 50 or over and have a defined contribution pension, you can get free guidance on the options available to you from the Government’s Pension Wise service. If you want personal recommendations or advice about your specific circumstances, you’ll need to seek professional financial advice. You can find a local financial advisor on VouchedFor or Unbiased, or for more information, check out our guide on How to find the right financial advisor for you.