Around 2,400 individual pension investors successfully claimed back more than £10,000 emergency tax on retirement income last year, with some people having to claim back over £100,ooo, according to figures published today.
Royal London, the UK’s largest mutual life, pensions and investment provider, obtained information from HMRC revealing the numbers following a Freedom of Information (FOI) request. People can currently access their pensions from age 55 (rising to 57 from April 2028).
According to the data, 11,700 pension savers claimed back £5,000 or morein the tax year 2023-24, an increase of 2,000 (21%) on the previous year.
Of those, 2,400 claimed sums in excess of £10,000, a year-on-year increase of 100 (4%).
The average refund per saver was £3,342, up £280 (9%) on the previous year, with many pension savers often having to wait to get the money back. Incredibly, the top 25 refunds averaged an eye-watering £106,897.
In total, around 60,000 investors claimed refunds in 2023-24 compared with approximately 50,000 the year previous, an increase of 20%.
Changes to pension rules in 2015 meant people can withdraw some or all of their defined contribution pension savings as lump sums from the age of 55. While 25% of pensions are normally tax free (capped at £268,275), the remaining 75% is taxed as income.
However, taxation of pension withdrawals remained similar to taxation of any other income, with an ‘emergency’ rate being applied where there wasn’t already a tax code in place. This means HMRC tax the amount withdrawn as if that will be the pension saver’s monthly income every month for the rest of that tax year.
For a first withdrawal, someone taking out £30,000 would normally receive £7,500 as tax free cash (25%) and the remaining amount is taxed as if their monthly income is £22,500, even if the pension holder has no intention of taking further pension income that year. In other words, they pay £8,503 in emergency tax, however if basic rate tax was applied it would be £1,984. The difference – £6,519 – needs to be claimed back.
Clare Moffat, pension expert at Royal London, commented: “It’s incredible to think that some people withdrawing from their pension for the first time were entitled to emergency tax refunds in excess of £100,000.
“Not only do these taxes usually come as a massive shock, the unexpected tax amount can also scupper people’s carefully laid 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.
“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.
“The data relating to those who paid more than £100,000 in emergency taxes will likely have included some people looking to fund home purchases, either for themselves or for a loved one. To trigger a tax bill of that size, they will have made a withdrawal in excess of £300,000.
“HMRC recently announced an overhaul of its emergency taxing codes on pensions, which it promises will deliver quicker refunds, but that doesn’t mean people won’t still be charged the higher rate in the first place.
“In fact, the recent announcement by the government that pensions will soon be subject to inheritance tax may have the knock-on effect of triggering a surge in emergency taxes on pension withdrawals.
“Looming inheritance tax means more and more people are considering dipping into their pension pots while they are alive for the purpose of making large lifetime gifts to loved ones, which are exempt from inheritance tax if the giver survives for seven-years after making the gift.
“A rise in large lump-sum withdrawals will likely mean an even greater spike in emergency taxes on those withdrawals. So, the problem of emergency taxes isn’t going away, and there’s a chance it could get worse.”
To get the money back, retirees must complete one of three forms before waiting on a refund. Approximately, £1.4billion has been refunded since 2015.
If they don’t fill out the paperwork, retirees will need to wait on HMRC reviewing the payments at the end of the tax year. In the past, this meant many were left out of pocket for many months.
One way people can avoid emergency taxes when taking money out of their pensions is by making a small initial withdrawal which will have the effect of triggering a less punitive tax code on future withdrawals. However, this would be less practical if a large sum was needed immediately.
Clare Moffat added: “The temptation is to make your first withdrawal a big one to splash out a little after years of careful saving. Unfortunately, that’s exactly how you end up paying a large chunk of your life savings in emergency tax.
For those who’ve benefited from financial advice in planning their retirement, advisers will highlight the value of withdrawing a modest taxable amount. This helps ensure a more appropriate tax code is applied to future withdrawals—so you only pay the tax that’s due, rather than being hit with emergency tax you’d need to reclaim later.”
