Savers slapped with ’emergency’ tax when making pension withdrawals are overcharged £3,350 on average
The taxman has repaid another £44.7million to people who were overtaxed when taking a lump sum from their pension pot, new figures show.
The sum covering July to September takes the total refunded since the beginning of pension freedoms in 2015 to almost £800million.
HMRC applies an emergency tax code to savers who make their first pension withdrawal, assuming they will take out a whole series of sums in that tax year even if they have no intention of doing so.
Overtaxed: HMRC applies an emergency tax code to savers who make their first withdrawal
They are taxed as if they would take the same amount every month, so those taking only a one-off lump sum end up overpaying tax.
They then either have to reclaim the tax themselves or wait for HMRC to give it back. The average tax refund between July and September was £3,352, HMRC figures show.
HMRC has signalled in the past it is not planning any change to the system, branded ‘totally unacceptable’ by This is Money’s agony uncle and former Pensions Minister Steve Webb.
Refunds to people who overpaid tax on their pension withdrawals have increased steadily, from £23million at the start of the year, to £33million between April and June, and now £44.6million in the most recent quarter.
‘Unacceptable’: This is Money’s columnist Steve Webb
‘The fact that overpayments are on the rise throughout the year suggests more and more pension savers are dipping into their pension,’ commented Jon Greer, head of retirement policy at Quilter.
Tom Selby, head of retirement policy at AJ Bell, said the Government should automate paybacks.
‘At the moment savers risk being left out of pocket to the tune of thousands of pounds when they access their retirement pot.
‘If this process could be automated and the need to fill out a complex reclaim form removed, it would significantly improve the tax system for retirees.’
What should you do if HMRC makes an ’emergency’ tax raid on your pension cash?
This is Money columnist Steve Webb replied to a reader question about this here.
He explained that those taking a regular income from their pension pot should have their tax code adjusted automatically.
But anyone making a single withdrawal in the tax year will need to fill out one of three HMRC forms, depending on their circumstances, to get their money back within 30 days.
Webb said those who have taken a partial withdrawal but left money in their pension pot will need to complete form P55.
For someone who has emptied their pot and is no longer in work, the form is the P50Z.
And for someone who has emptied their pot but is continuing in employment the form is the P53Z.
Kate Smith, head of pensions at Aegon, suggested people could make two withdrawals instead of one to avoid being overtaxed.
‘As it looks as though HMRC has little appetite for addressing this convoluted way of overpaying then reclaiming tax, individuals should consider taking out a tiny first pension payment, then taking out a second higher payment in the same tax year, where the amount of income tax will be adjusted.