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Blow to millions as HMRC continues pension freedoms overtax rule

Written by: Paloma Kubiak
Millions of retirement savers will continue to be overtaxed on withdrawals under pension freedoms as HMRC stands firm on its current rules.

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 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 savers actually take. Savers then need to reclaim their money back. See’s guide to Reclaim the tax on pension freedoms withdrawals for more information.

It was hoped HMRC would re-think this stance but it confirmed the following: “We’ve concluded that any changes at the current time would not significantly improve the tax position for the majority of recipients of a flexible drawdown payment when compared to the process currently in place.

“The existing PAYE treatment of flexible pension drawdowns remains the most effective method of deducting tax in these cases and it reduces the risk of underpayments of tax arising.”

It added it will continue to keep the current process under review and monitor drawdowns and related claims.

Tom Selby, senior analyst at AJ Bell, said this is a “disappointing stance” from HMRC when you consider that people withdrawing their pension have been overtaxed by hundreds of millions of pounds over the past few years.

“While almost £300 million has been repaid to savers since the pension freedoms were introduced, many more who didn’t fill out the required forms will have been left short-changed for up to a year.

“By continuing to overtax people who use the pension freedoms as the government intended, HMRC risks pushing people into financial difficulty and forcing them into taking out more than they need to, potentially creating an extra tax liability as a result.”

Kate Smith, head of pensions at Aegon, said a workaround for people is to withdraw a small amount as the first payment.

“This will prompt HMRC to issue the correct tax code to the pension provider. Then when the individual withdraws a larger amount, say, the following month, the income tax deduced should be correct. Emergency rate tax will still be made on the first payment, and have to be reclaimed, but individuals won’t be so much ‘out of pocket’.”

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