How to claw back tax overpaid when opting for pension drawdown
Many retirees opting for drawdown schemes – taking money out of their pension savings – have overpaid tax. Here’s what to do to get it back.
Savers received record average tax refunds of £3,560 each in the second quarter of 2020 after being overtaxed on withdrawals from their pensions. Total refunds since the pension freedom reforms of 2015 have now reached £627m.
The issue affects many savers opting to use drawdown schemes to access their pension funds on reaching retirement, rather than converting savings to income by buying an annuity. While savers may take the first 25% of their money tax-free, withdrawals above this amount are taxable at their marginal rate of income tax.
Drawdown plan providers often do not have an up-to-date tax code for savers taking money out of their funds in this way for the first time and are therefore forced to apply an emergency tax code. This often results in savers paying too much tax on their withdrawals, particularly on larger sums. The money then has to be reclaimed.
The government has been urged to address this problem since the pension freedom reforms encouraged many more savers to consider drawdown plans. But while hundreds of thousands of savers have been caught out in this way over the past five years, HMRC has yet to find a solution to the problem. In the meantime, savers entering drawdown for the first time must check their tax position carefully.
It may be possible to avoid the problem. One workaround suggested by some pension providers is to treat your first withdrawal as a means to establish your tax position: where you’re intending to make a withdrawal above the 25% tax threshold, keep the additional sum to a minimum so you pay only a small amount of tax at the emergency rate.
Your pension provider should then be able to liaise with HMRC to ensure you pay the right amount of tax on subsequent withdrawals, though it may take a few weeks for the correct tax code to come through. Alternatively, those who do pay too much tax do not have to wait until the end of the tax year to reclaim what they are owed. While one option is to claim the excess back on your self-assessment tax return, you can secure a more speedy refund by making an immediate application to HMRC.
However, you will need to complete the right form. Savers who haven’t withdrawn their entire pension should use the P55 form to reclaim their excess tax; those who have withdrawn all their savings and have taxable income will need form P53Z. If you have no other taxable income, complete P50Z. The forms are at www.gov.uk/claim-tax-refund – you will need a Government Gateway account – and HMRC says refunds are paid within 30 days.