Thousands fail to reclaim tax overcharged on pension freedom withdrawals
Tens of thousands of individuals aged 55+ who have used pension freedoms since its inception two years ago have failed to reclaim millions of pounds in overpaid tax that would have been charged on their first withdrawals.
This is because when someone takes their first flexible withdrawal from their pension, it’s more likely that their pension provider will not have a tax code for them.
But under HM Revenue & Customs (HMRC) rules, pension providers apply tax on a ‘month 1’ basis so the withdrawal is counted as if that amount of money will be taken every month during the year, rather than as a one-off withdrawal.
The tax is therefore calculated based on a much higher annual withdrawal than the savers actually take.
Investment platform AJ Bell explains that someone withdrawing £10,000 from their pension deliberately to keep themselves under the personal allowance would have expected to pay no tax. But instead, they may actually have paid £3,099 in tax.
This is because under a ‘month 1’ basis it would be treated as the first of twelve £10,000 withdrawals and tax would be calculated based on £120,000 being withdrawn throughout the year.
On a modest £5,000 withdrawal, again the individual (basic rate taxpayer) would expect to pay no tax but AJ Bell calculates they may have been charged £1,099 on the ‘month 1’ basis.
A basic rate taxpayer withdrawing £40,000 under pension freedoms would expect to pay £5,798 in tax but in reality once the emergency tax code is applied, they could actually end up paying £16,428.
How to reclaim your money
This tax can be reclaimed from HMRC but analysis of data shows far fewer people have made the reclaim than have accessed the pension freedoms.
Since the pension freedoms were introduced in April 2015, an average of 139,000 pension pots per quarter have been accessed for the first time using flexi-access drawdown or a lump sum payment. The majority of these initial withdrawals are likely to have been taxed on a month 1 basis under HMRC rules.
However, HMRC data for 2016 shows that on average only 10,998 reclaims for overpaid tax have been made per quarter.
If you think you may have overpaid tax, you should visit the government’s Claim a tax refund site which states:
- If the payment used up your pension pot and you have no other income in the tax year, fill in form P50Z.
- If the payment used up your pension pot and you have other taxable income, fill in form P53Z.
- If the payment didn’t use up your pension pot and you’re not taking regular payments, fill in form P55. You can only use this form if your pension provider can’t refund you.
Tom Selby, senior analyst at AJ Bell, said: “HMRCs insistence that an emergency tax code must be applied to pension freedom withdrawals means tens of thousands of people will have paid too much tax on their withdrawals yet very few of them have reclaimed it so far.
“This might be because they don’t know they have paid too much tax or the process to reclaim it just seemed too complicated. Whatever the reason, there is likely to be millions of pounds sat with HMRC that could be legitimately reclaimed. It is up to individuals to check [their status.]”