Pensioners reclaim £44 million from HMRC – are you owed money?

The misery of applying for pension tax refunds is still dragging on, with HMRC paying out £44 million in the third quarter of this year to pensioners who have been overtaxed.

More than 12,000 reclaim forms were processed by HMRC from July to September, with an average pension tax refund of £3,691.

The over-taxation occurs when too much tax is taken off withdrawals from pension pots. It typically happens when a retiree accesses their pension for the first time and pays an emergency rate of tax.

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In the previous quarter (April to June), HMRC paid out an even higher £57 million, with more than 16,000 reclaim forms processed.

About £1.3 billion has now been reclaimed by people overtaxed on pension withdrawals since 2015 when pension freedoms came into effect. The freedoms mean retirees do not have to buy an annuity and are free to take either a regular income from their pension pot or ad-hoc withdrawals as they please.

Helen Morrissey, head of retirement analysis at the investment platform Hargreaves Lansdown, says being overtaxed can cause pensioners “huge problems” and that a “tax nightmare” is not a good way to start your retirement.

She adds: “More than nine years after pension freedoms it is inconceivable to think that people are still being overtaxed on their first pension withdrawals. Many of these people will not have been expecting this, and will have had a nasty shock when their tax bill was way higher than expected.”

While the amount of tax reclaimed has fallen compared to the previous quarter, experts fear that we could see a jump in the next set of data due to worries around next week's Budget.

Jon Greer, head of retirement policy at the wealth manager Quilter, comments: "What’s particularly concerning is that we may see a sharp rise in withdrawals, driven by growing anxieties surrounding the upcoming Budget. With persistent rumours and the government’s rhetoric pointing to a ‘painful’ fiscal event, many savers may take tax-free cash from their pension pots, fearing potential changes to pension taxation. This could lead to hasty decisions, which may not be in their long-term financial interests."

Why are savers overtaxed on pension withdrawals?

Pension savers are allowed to take money out of their self-invested personal pensions (Sipps) and workplace schemes as they wish from age 55 (rising to 57 in 2028). So, for instance, they could withdraw £500 one month, £1,500 the next month, and nothing for the rest of the year.

Pension withdrawals are subject to income tax, bar the 25% tax-free cash. HMRC taxes the first flexible withdrawal someone makes in a tax year on a “Month 1” basis. This means the amount withdrawn is taxed as if that will be the pension saver’s income every month for the rest of the tax year. In other words, a lump sum withdrawal is treated as though you will take the same income every month.

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 will likely be left out of pocket.

A Freedom of Information request lodged, earlier this year, by the insurer Royal London revealed that hundreds of retirees have been overtaxed by more than £15,000, with some having to apply for refunds worth a staggering £50,000.

Greer comments: “The tax system's inherent flaws place a heavy burden on retirees. The PAYE system, while effective for regular income, struggles to accommodate the way pensions are accessed under the freedoms introduced in 2015.

“Until the system is changed, we are likely to continue seeing many savers caught out and forced to reclaim significant sums of money.”

How can retirees avoid being overtaxed? 

One way to avoid being overtaxed and having to apply for a refund is by making your first pension withdrawal a small one, if possible.

This should mean HMRC is able to apply the correct tax code to the second, larger withdrawal.

How can pensioners claim a tax refund?

If you are hit with emergency tax, you can complete a form and apply for a refund, or wait for HMRC to put you in the correct position at the end of the tax year.

• If you are taking only some of your pension pot, you should fill out the P55 form.
• If you are taking the whole lot, and have no other income sources for that tax year, fill out P50Z. If you do have another income, complete form P53Z.

Refunds are usually paid within 30 days and are sent directly to your bank account.

Note: 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 right amount.