Are you owed back tax on your pension? HMRC quirk eating into retirees’ income

Retirees making flexible withdrawals from their pension have been temporarily shortchanged by nearly £1.5bn due to a quirk in HMRC’s systems.

New figures showed that in April, May and June this year Brits reclaimed £49 million of money where they have overpaid tax on their pension withdrawals. During the period nearly 13,000 reclaim forms were processed, with an average reclaim of £3,815. It takes the total amount of reclaimed tax to £1.5bn since 2015, when the problem began.

These figures are likely to be the tip of the iceberg, however, as they only capture those who fill in the relevant HMRC reclaim form. In reality, many will be reliant on HMRC putting their affairs in order at the end of the tax year to get their money back.

Source: AJ Bell analysis of HMRC data

Why are savers overtaxed on pension withdrawals?

Since 2015, HMRC has chosen to tax the first flexible pension withdrawal someone makes in a tax year on a ‘Month 1’ basis. This means HMRC divides your usual tax allowances by 12 and applies them to the withdrawal.

While those who take a regular income or make multiple withdrawals during the tax year should be put right automatically by HMRC, anyone who makes a single withdrawal in a tax year will likely be left out of pocket.

It’s possible to get your money back within 30 days, but only if you fill out one of three HMRC forms to reclaim your money. If you don’t, you are left relying on the efficiency of HMRC to work out that you’ve overpaid tax and repay you at the end of the tax year.

Read more about how pension withdrawals are taxed.

How to get your money back if you are overtaxed

Savers who are planning to take a single withdrawal in a tax year can potentially avoid being overtaxed by taking a notional withdrawal first. In a notional withdrawal, you make just a small transaction, like £1 (or the smallest withdrawal your provider will allow). This small transaction will be coded with the tax code for that ‘Month One’ withdrawal.

This should mean HMRC is able to issue the correct tax code to the second, larger withdrawal. But, be aware that if your pension provider only allows you to remove a larger amount, like £100 in your first small transaction, you might still need to claim the tax back on that amount. It would just be a much smaller claim than the main withdrawal you were planning to take.

Alternatively, you can make your first withdrawal as planned and then fill out one of three HMRC forms and you should receive your money back within 30 days. If you don’t do this, the Revenue says it will put you back in the correct tax position at the end of the tax year.

If you are taking a steady stream of income via drawdown then you shouldn’t need to take any action, as HMRC will adjust your tax code to ensure that over the course of the year you are taxed the correct amount.

Which form you need to fill out will depend on how you have accessed your retirement pot:

• If you’ve emptied your pot by flexibly accessing your pension and are still working or receiving benefits, you should fill out form P53Z,
• If you’ve emptied your pot by flexibly accessing your pension and aren’t working or receiving benefits, you should fill out form P50Z,
• If you’ve only flexibly accessed part of your pension pot, then use form P55.