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Pension freedoms overtaxation approaches £800 million

Tom Selby, senior analyst at AJ Bell
Tom Selby, head of retirement policy, AJ Bell
  • New figures from HMRC reveal £794 million has now been repaid to people overtaxed on retirement withdrawals since the pension freedoms were introduced in April 2015
  • Between July and September 2021 almost £45 million was repaid to savers, with an average reclaim of £3,352 [Pension schemes newsletter 134 — October 2021 – GOV.UK (www.gov.uk)]
  • Issue occurs because HMRC insists savers flexibly accessing taxable income from their retirement pot for the first time are taxed on a ‘Month 1’ basis
  • This means their usual tax allowances are divided by 12 and applied to the withdrawal – meaning people could be hit with shock tax bills running to thousands of pounds
  • Those who only make one withdrawal in the tax year need to fill out one of three HMRC forms in order to get their money back

Tom Selby, head of retirement policy at AJ Bell, (pictured) comments:

“Savers accessing their pension need to be aware that HMRC will apply an emergency ‘Month 1’ tax code to their first withdrawal, meaning they will initially be overtaxed – potentially by thousands of pounds.

“While those taking a regular income should have their tax code adjusted automatically, anyone making a single withdrawal in the tax year will need to fill out one of three HMRC forms to get their money back within 30 days.

“If they don’t, they will need to wait to the end of the tax year, when HMRC says they should receive a rebate.

“The Government is looking at increasing digitisation in the administration of pension tax relief as part of the Budget. Policymakers should use this opportunity to assess the current approach to the taxation of pension freedoms withdrawals.

“At the moment savers risk being left out of pocket to the tune of thousands of pounds when they access their retirement pot. If this process could be automated and the need to fill out a complex reclaim form removed, it would significantly improve the tax system for retirees.”

Getting the money back

If you are taking a steady stream of income via drawdown then you shouldn’t need to take any action, as HMRC will adjust your tax code to ensure that over the course of the year you are taxed the correct amount.

However, if you make a single withdrawal then you will either need to take action by filling out one of three forms or rely on HMRC putting you in the correct position 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.

Provided you fill out the correct form HMRC says you should receive a refund of any overpaid tax within 30 days.

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