Record level of overpaid pension tax
One of the downsides associated with pension freedoms and the ability to withdraw income flexibly from pension pots is too much tax deducted by the taxman.
If you’re over the age of 55, it’s possible to withdraw a quarter of your pension pot tax-free, and then withdrawals from the balance of the pension pot are subject to the various rates of income tax.
But if you’re making a withdrawal from your pension pot for the first time, there’s a good chance your pension provider will use an emergency tax code to calculate any income tax due.
Pension providers resort to the use of an emergency tax code where they don’t have your up-to-date tax code, which tells them your earnings to date in that tax year.
This emergency tax code is calculated as 12 times your first withdrawal, against which only one-twelfth of your income tax-free personal allowance is applied. The combination of a higher than actual forecast income and much lower personal allowance usually results in much higher than accurate income tax deductions.
The good news is, you can reclaim overpaid income tax back.
According to new figures from HM Revenue & Customs, the amount of overpaid income tax reclaimed by pension savers has reached a new record level in the latest quarter.
Looking at the three months to the end of September, HMRC paid back more than £54 million in overpaid tax on pension withdrawals. This is the highest quarterly level of tax repayments since the pension freedoms were originally introduced in April 2015.
Since the pension freedoms came into force, HMRC has overtaxed and then repaid £535 million in taxes, due to this emergency tax code approach.
Claiming back overpaid tax when making pension withdrawals means completing one of three HMRC forms, or waiting to use the year-end tax return process.
The government’s Office for Tax Simplification recognises the unnecessary complexity involved in this emergency tax code system and has called on HMRC to review the process. Despite this call for a review, HMRC has refused to take action.
Steve Webb, Director of Policy at Royal London said:
“Even by their own low standards, HMRC have outdone themselves in the last three months, taking more than £54m of savers’ money in income tax to which they were not entitled.
“It cannot be right that tens of thousands of people each year have too much tax taken out of their pension and then have the hassle of filling in a form to get back money that is rightfully theirs.
“Whoever ends up running the country after the General Election needs to tell HMRC to stop this practice as a matter of urgency.”
If you’re making a taxable withdrawal from your pension pot, and you have access to a current P45, it’s worth passing a copy of this to your pension provider in the first instance, so they can apply the correct tax code.
If it’s not possible to give your pension provider a current tax code, then calling HMRC as soon as an overpayment of tax has been taken is the fastest way to obtain a refund.