Savers have been refunded almost £1.2 billion in overpaid tax since pension freedom rules were introduced, government figures show.
A quirk in the tax rules when it comes to accessing retirement funds under pension freedom rules means that savers can end up paying too much to HM Revenue and Customers (HMRC) when making pension withdrawals.
The latest HMRC data shows savers reclaimed more than £38 million in overtaxation on pension withdrawals between October and December 2023.
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More than 12,000 reclaim forms were processed during the quarter, with an average reclaim of £3,216 and it takes to total amount of refunds for overtaxed withdrawals close to £1.2 billion since 2015.
Tom Selby director of public policy at AJ Bell warns that the true overtaxation number could be substantially higher.
“In particular, people on lower incomes who are less familiar with the self-assessment process might be less likely to go through the official process of reclaiming the money they are owed,” he says.
“As a result, they will be reliant on HMRC putting their affairs in order.”
How can pension withdrawals be overtaxed?
Former chancellor George Osborne’s pension freedom rules were introduced in 2015, letting retirees access their pension pots with more flexibility beyond having to buy an annuity or enter drawdown.
It meant that any pension withdrawals, beyond the 25% tax-free lump sum, were taxed at each individual’s own tax rate.
But while this area of pensions was modernised, the tax system has failed to keep up.
When accessing money in your pension the first time or making a single withdrawal, HMRC
divides your usual tax allowances by 12 and applies them to the withdrawal.
Selby warns this can hit hard-working savers with shock tax bills often running into thousands of pounds.
While those who take a regular income or make multiple withdrawals during the tax year should be put right automatically by HMRC in their tax code, anyone who makes a single withdrawal will likely be left out of pocket, Selby warns.
“We are approaching the 10-year anniversary of former chancellor George Osborne’s bombshell pension freedoms announcement at the March 2014 Budget,” adds Selby.
“While those reforms have been widely welcomed by savers, who now have total flexibility over how they access their retirement pot from age 55, the government’s own tax systems remain stuck in the dark ages.
“It is simply unacceptable that the government has failed to adapt the tax system to cope with the fact Brits are able to access their pensions flexibly from age 55, instead persisting with an arcane approach which hits people with an unfair tax bill, often running into thousands of pounds.”
How to get your money back if you are overtaxed
Getting your money back can involve a lot of administration.
It is possible to get a refund within 30 days, but only if you complete one of three HMRC forms to reclaim your money. Otherwise you have to wait on the kindness and efficiency of HMRC to repay you at the end of the tax year.
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.
This tax trap can also be avoided by thinking about how you access your pension.
“One way savers planning to take a single withdrawal in a tax year can potentially avoid the shock of a big overtaxation bill is by taking a notional withdrawal first,” says Selby. This should mean HMRC is able to apply the correct tax code to the second, larger withdrawal.
“Alternatively, you can fill out one of three HMRC forms and you should receive your tax 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.”
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