Pension tax refunds: how to get your money back if you have been overtaxed on withdrawals

Pension savers reclaimed over £56 million in overtaxation on pension withdrawals in April, May and June this year – the highest three-month figure since records began. This is up from £48.5 million in the first quarter of the year.

Those who were overtaxed when making a withdrawal from their pension reclaimed an average of £3,551 each – the second highest figure since the pension freedoms were introduced in 2015.

But, experts have hit out at the statistics, saying it is “unacceptable” that the government has not changed the tax system to better accommodate how people now access their pots.

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Tom Selby, head of retirement policy at AJ Bell says the “arcane” method currently in use “hits people with an unfair tax bill, often running into thousands of pounds, and requires them to fill in one of three forms if they want to get their money back within 30 days.”

He adds: “While it is arguably positive savers successfully reclaimed a record £56 million in the latest quarter, it is ridiculous they have to go through this process at all. And depressingly, the true overtaxation number will likely 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. As a result, they will be reliant on HMRC putting their affairs in order,” he says.

Steve Webb, partner at pension consultancy LCP and a former pensions minister, previously said the situation was “an absolute disgrace”.

“There is no good reason why citizens who access their pension should have to go through the hassle of claiming back excess taxation which they should never have had to pay in the first place.”

We explain why pension withdrawals are being overtaxed, and how can you get your pension tax money back?

Why are pension withdrawals being overtaxed?

The issue around the taxation of pension withdrawals is nothing new ‒ it’s been an issue since the launch of the pension freedoms, which gave savers a greater range of options around how to access their pension pot.

In fact, since 2015 more than £1 billion has been returned to savers who have been overtaxed on their pension withdrawals.

It all comes down to the way that HMRC approaches withdrawals.

When a pension saver makes their first withdrawal from their pension pot, the taxman taxes it on a ‘month one’ basis. This means that it views this initial withdrawal as if it is going to be repeated in each month over the year.

As a result, just 1/12th of the personal allowance is applied to the payment, with the remainder assessed against 1/12th of the income tax bands in place.

The reality may be that you are simply withdrawing a lump sum as a one-off, but because of this approach from HMRC you end up being hit with an enormous tax bill.

How much will my pension withdrawal be overtaxed?

So what can these overtaxations look like in practice?

Here’s an example outlined by Royal London. The pension saver wants to take a £50,000 lump sum from their pot, and can get 25% of that sum tax free, which works out at £12,500. The remaining £37,500 is therefore subject to tax.

Because HMRC treats that withdrawal as if the saver would be receiving that sum every month, they are treated as if they are an additional rate taxpayer. This would mean they were not eligible for the personal allowance, and would end up with a tax bill of above £15,000. As a result, in attempting to take out a lump sum of £50,000, they would only actually receive less than £35,000.

The correct level of tax would vary based on the individual’s circumstances and their income tax band, but only for those earning the highest incomes would it come to above £15,000.

According to the HMRC data, the average amount reclaimed in the first quarter of 2023 came to £3,062. That’s slightly down on the previous quarter, which pension experts have suggested points to pension savers starting to access smaller pots.

How can I reclaim the overpaid tax on my pension?

The route for reclaiming money that has been overpaid to the taxman will vary, based on how you handle withdrawals after that first one.

If you make regular withdrawals at lower levels, then the taxman will automatically adjust your tax code. As a result you should end up paying the right amount overall, meaning you don’t actually need to do anything.

The problem comes for those who are only making a single withdrawal, since that doesn’t give HMRC the chance to correct its initial error.

If you do just make a one-off withdrawal, then you have a couple of options. The easiest is to just wait until the end of the tax year, when you file a self assessment. At this point HMRC will realise it has overcharged you and so return the money to you.

Obviously this is less than ideal if you need that money relatively soon, in which case you will need to fill out a form. There are three different forms to choose from:

• The P53Z form ‒ this is if you are still working or receiving benefits, and have withdrawn your entire pension pot
• The P50Z form ‒ this is the form you need if you are not still working or receiving benefits, and have emptied your pot
• The P55 form ‒ this is the form to go for if you have only withdrawn a portion of your pension pot
• The P53 form ‒ this is the form to go for if you have withdrawn up to £30,000 under the small pots arrangement

You can get these forms on the Government’s website.

The taxman reckons that refunds are paid within 30 days of receiving one of these forms.

How to avoid being overtaxed on your pension withdrawals

While HMRC apparently shows no intention of adapting its approach to taxing pension withdrawals, there may be a workaround for pension savers who want to avoid falling foul of the issue.

Andrew Tully, technical director at Canada Life, suggests that pension savers who are making a withdrawal for the first time should opt for a small amount, say £100.

He explains: “That will generate a tax code from HMRC which the pension provider will apply to any subsequent withdrawals. That will result in the tax being taken at source being far more accurate in many more cases, not only reducing the burden of paperwork but equally importantly the customer receiving a more accurate withdrawal in the first place.”

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