Pension tax ‘nightmare’ – now HMRC makes savers pay millions in tax they don’t even owe | Personal Finance | Finance
Savers making withdrawals from their pension pots have overpaid a staggering £835 million in tax since 2015. That includes £42 million in the last three months, with the average bill topping £3,000 each.
The over 55s are now allowed to withdraw cash from their pension pots, following 2015’s pension freedom reforms.
Yes HMRC slaps them with an emergency tax wish that exaggerates how much many of them are likely to pay.
Tax experts say this overtaxation is “an ongoing nightmare” and are calling on HMRC to fix the system given the huge popularity of pension withdrawals.
While savers will eventually get their money back they have to jump through hoops first, and the system is slow and complicated.
Any tax overpayments are refunded automatically where savers draw a regular monthly income from their pension.
However, where savers make a single withdrawal they are treated as if they were going to carry on taking that sum every single month for the rest of the tax year, even if they’re not.
Incredibly, the first flexible withdrawal of the tax year is taxed under something called a ‘Month 1’ emergency tax code, said Tom Selby, head of retirement policy at AJ Bell.
It divides the normal tax allowances by 12 and applies them to the first withdrawal. “Those taking a one-off lump sum are likely to pay far too much tax on it.”
Many savers do not realise they are going to be automatically overtaxed so the bill comes as a total shock.
This can cause cash flow problems, with reclaimed amounts averaging £3,107 per person in the last three months of 2022. “Savers continue to be hit in the pocket by HMRC simply for accessing their own retirement pot,” Selby said.
In practice, the total overtaxation bill is likely to be much higher than £835 million, as official figures only cover people who fill out reclaim forms.
“HMRC says those who don’t go through this process will be refunded at the end of the tax year,” Selby added.
But it is “beyond belief” that the tax system continues to operate in this way almost seven years after pension freedoms were launched. “An upgrade is long overdue,” he added.
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These overpayments are not the result of some kind of horrible mistake by the taxman, said Helen Morrissey, senior pensions and retirement analyst at Hargreaves Lansdown. “It’s how the system is intended to work.”
Anybody caught up in this administrative nightmare has a choice. They can either fill out one of three different official forms to get their money back, or wait until the end of the tax year for a rebate.
Which form you use to claim an overpayment depends on your personal circumstances. Use P50Z if the payment used up your entire pension pot and you have no other income that tax year.
Alternatively, use form P53Z if the payment used up your pension but you do have other taxable income. If you have withdrawn only part of your pot and you are not taking regular payments, complete form P55.
Otherwise claim the money back through your self-assessment tax return.
Morrissey called on the Government to “bring this system out of the dark ages”: “This is an administrative nightmare that should have been sorted long ago, rather than forcing people to navigate a highly complex system filling out various forms to get their hands on their own money.”
Which form you used to claim an overpayment depends on your personal circumstances. Use P50Z if the payment used up your pension pot and you have no other income that tax year.
Alternatively, use form P53Z if the payment used up your pension and you have other taxable income. If you have withdrawn only part of your pot and you are not taking regular payments, complete form P55.
Otherwise claim the money back through your self-assessment tax return.
Morrissey called on the Government to “bring this system out of the dark ages”: “This is an administrative nightmare that should have been sorted long ago, rather than forcing people to navigate a highly complex system filling out various forms to get their hands on their own money.”
