£283 million in overpaid tax repaid to pension savers so far
Average overpayment is £2,420
Problem is most acute at the beginning of the tax year
Savers planning to make ad-hoc pension freedoms withdrawals in the new tax year face being overtaxed by thousands of pounds and having either to wait at least 12 months to get their money back or contact HMRC to ask for it back.
The problem can affect anyone who takes a taxable pension freedoms payment from age 55 – either through drawdown or via an ‘Uncrystallised Funds Pension Lump Sum’ (UFPLS) withdrawal.
In these circumstances, HMRC requires pension providers to use an emergency ‘Month 1’ tax code. This means the Revenue only gives you 1/12th of the usual tax allowances available on the withdrawal, resulting in many savers being severely overtaxed.
For example, someone who makes a £2,000 withdrawal could be overtaxed by over £200, while someone taking out £10,000 could be overtaxed by over £3,000 (see Tables 1 and 2 at the end of this release).
Tom Selby, senior analyst at AJ Bell, comments:
“Tens of thousands of people using the pension freedoms every month risk falling into this tax trap. On average, the level of over-taxation runs into thousands of pounds and for some it could be tens of thousands of pounds.
“The problem is at its most acute at the beginning of the tax year as anyone who makes an ad-hoc withdrawal and doesn’t fill out the right form to claim the money back will have to wait until at least April 2019 to get their money back. Even then, you are relying on the efficiency of HMRC to put you back in the position you should have been in in the first place.
“This is no small issue. According to HMRC data, around 140,000* pension pots have been accessed for the first time every quarter since the pension freedoms were introduced. The vast majority of these are likely to have been taxed on a ‘Month 1’ basis.
“However, on average, only 10,500 official reclaim forms have been processed each quarter by HMRC, worth a total of £283 million**.
“This is not an academic problem either – savers accessing their pensions for the first time using the freedoms understandably expect to receive the correct amount of money. Many will have specific plans for their withdrawal, such as to pay down debt or fund long-term care for an elderly relative. For people like this, getting thousands of pounds too little will present a serious financial challenge.
“HMRC should, at the very least, consult on its approach to single pension freedoms withdrawals and review the risks it poses to savers. Allowing providers to apply a ‘Month 12’ tax code would be a more consumer-focused solution, with HMRC taking responsibility for recouping any underpaid tax.”
Pension freedoms over-taxation - how the system works***
Table 1 – tax an individual would expect to pay
Withdrawal | Expected tax due | Effective tax rate |
£2,000.00 | £0.00 | 0.00% |
£5,000.00 | £0.00 | 0.00% |
£10,000.00 | £0.00 | 0.00% |
£20,000.00 | £1,698.20 | 8.49% |
£50,000.00 | £8,696.40 | 17.39% |
Table 2 – tax an individual actually pays on ad-hoc freedoms withdrawals
Withdrawal | Tax due under ‘Month 1’ | Effective tax rate |
£2,000.00 | £208.18 | 10.41% |
£5,000.00 | £1,058.03 | 21.16% |
£10,000.00 | £3,058.03 | 30.58% |
£20,000.00 | £7,385.08 | 36.93% |
£50,000.00 | £20,885.08 | 41.77% |
* Source: HMRC data
** Source: HMRC Pension Schemes newsletters
***all examples assume individual has no other taxable income
How to make a reclaim
How people make a claim for any overpaid tax depends on the nature of the withdrawals they have made from their pension and their personal circumstances.
The Government website states:
If the payment used up your pension pot and you have no other income in the tax year, fill in form P50Z.
If the payment used up your pension pot and you have other taxable income, fill in form P53Z.
If the payment didn’t use up your pension pot and you’re not taking regular payments, fill in form P55. You can only use this form if your pension provider can’t refund you.