Around 60,000 savers claimed a tax refund in 2023/24 after being overcharged on pension withdrawals, according to figures obtained by financial services firm Royal London.
Many savers were entitled to thousands of pounds, with 11,700 pensioners claiming back £5,000 or more. Around 2,400 claimed back more than £10,000, with some of the largest claims coming to more than £100,000.
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HMRC will usually set things straight at the end of the tax year without you having to do anything – however there are steps you can take to get your money back more quickly, or to avoid being overcharged by a large amount in the first place. We take a closer look.
How much emergency tax could you be charged?
Imagine you withdrew £40,000 from your pension. How much emergency tax could you be charged?
If you took the money through an Uncrystallised Funds Pension Lump Sum (UFPLS) arrangement, £10,000 would be tax-free and the remaining £30,000 would be subject to income tax. This is because you are entitled to take up to 25% of your pension pot as tax-free cash.
“If this were treated on an emergency tax basis, this would come to £11,879 in tax,” said Helen Morrissey, head of retirement analysis at Hargreaves Lansdown. As introduced previously, this is because HMRC has assumed you are going to withdraw the same amount every month and is taxing it accordingly.
“As a result, the income tax payment is calculated using 1/12th of your personal allowance, 1/12th of your basic-rate tax allowance and 1/12th of your higher-rate allowance. The remainder is taxed at additional tax rates,” Morrissey said.
Using an emergency tax calculator can help you work out how much you could be charged on your first taxable pension withdrawal.
LCP partner and former pensions minister Steve Webb has called for the whole system to be “simplified and made more predictable” for people drawing on their pensions.
“This is a system designed for the convenience of the tax office, not the taxpayer,” he said. “Given that most people in retirement pay tax at the basic rate, it would not be difficult to have a system which got things right for most people most of the time, rather than making overtaxing people part of business as usual.”
Will HMRC reforms reduce overtaxation?
HMRC updated its system from April this year to move savers onto the correct tax code more quickly. Despite this, limitations mean the changes will only improve things for those taking a regular income. Those who make a one-off withdrawal will continue to be overtaxed.
Some experts believe the changes do not go far enough.
“We have only just blown out the candles on the cake celebrating 10 years of pension freedoms,” said Tom Selby, director of public policy at investment platform AJ Bell. “It is simply unacceptable that after all this time, the government has still not managed to adapt the tax system to cope with the fact Brits are able to access their pensions flexibly from age 55.”
Thankfully, there are some steps savers can take to reduce the impact of a shock tax deduction. For example, experts often recommend making a small withdrawal first. HMRC should then apply a more appropriate tax code to any subsequent larger withdrawals.
Taxpayers who find themselves submitting a reclaim form for a large amount of money may not have been aware of this tip.
For example, some of the savers highlighted by Royal London reclaimed more than £100,000 in overpaid tax in 2023/24. To generate an emergency bill of this size, they would need to have withdrawn more than £300,000 when first accessing their pension.
Savers do ultimately get this money back from HMRC. Even if they don’t actively claim it, things should get settled up automatically at the end of the tax year. Despite this, delays (or alternatively form filling) can be inconvenient and disrupt your immediate plans.
“Suddenly, that large chunk of money which had been earmarked for something special, like a new kitchen or the holiday of a lifetime, has shrunk considerably, and in some cases these plans may have to be postponed or abandoned altogether,” said Clare Moffat, pension expert at Royal London.
“If these withdrawals are being made to help children or grandchildren get a foot on the housing ladder, then the effect can be to derail a home purchase at the last minute when it’s discovered that the money required to complete the purchase has suddenly been eroded.”
How to claim a pension tax refund
If you are taking a regular stream of income through pension drawdown, you shouldn’t need to do anything. HMRC should adjust your tax code throughout the year to ensure you have paid the correct amount of tax overall.
If you make a one-off, ad hoc withdrawal, you can submit a form to reclaim the overpaid tax. This is usually refunded within 30 days. You will need to select one of three forms:
- P55: Choose this one if you have only accessed part of your pension pot.
- P53Z: Choose this one if you have emptied your pension pot, and are still working or receiving benefits.
- P50Z: Choose this one if you have emptied your pot, but are no longer working or receiving benefits.
These forms can be found on the government website.
Otherwise, you can wait for HMRC to set things right at the end of the tax year, when they should automatically refund you any overpayment. It is always worth double-checking this has been done correctly rather than just relying on the taxman.
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