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‘Clumsy system’ sees pension freedoms users reclaim £37m of tax

Paloma Kubiak
Written By:
Paloma Kubiak

People aged 55+ using pension freedoms to withdraw money from their lifetime savings pots have had to reclaim £37m from the tax man.

Quarterly statistics from HM Revenue & Customs (HMRC) reveal that between 1 July to 30 September 2017, it repaid a total of £36,875,395 in overcharged tax, wrongly applied when people exercise their pension freedoms to withdraw money from their pension pots.

The average tax reclaim in the past quarter is just under £2,300, with around 8% of those who took a flexible payment from their pension making a reclaim.

Since the dawn of pension freedoms in April 2015, a staggering £262m has now been repaid to savers being overcharged on tax. However, as the HMRC statistics only capture the total repaid from people who have actively reclaimed their money, the true figure in overcharged tax is likely to be much higher.

Tom Selby, senior analyst at AJ Bell, said: “While hundreds of millions of pounds has been successfully reclaimed by individuals overtaxed on pension freedoms withdrawals, this could be the tip of the iceberg. Many of those affected – particularly basic rate taxpayers and people who don’t take advice – could end up getting thousands of pounds less than they thought they would when they made the withdrawals.”

Why are savers overcharged on tax?

Pension freedoms rules allow anyone over the age of 55 unfettered access to their pension pots with the first 25% being tax-free.

When someone takes their first flexible withdrawal from their pension, providers apply tax on a ‘month one’ basis so the withdrawal is counted as if that same amount of money will be taken every month during the financial year, rather than viewing it as a one-off withdrawal.

As a result, this ‘emergency tax’ is usually calculated on a much higher annual withdrawal than the pension saver actually takes.

Tom McPhail, head of policy at Hargreaves Lansdown, said in theory HMRC processes mean even if you don’t fill in the form and immediately reclaim overpaid tax, you should eventually get the money back.

“The problem is HMRC isn’t infallible: if you don’t take the initiative and ask for the money back, you risk missing out; at best you’ll miss out on the use of the money for up to a year.

“This is a clumsy system which is certainly not designed with the best interests of the investor at its heart. HMRC and pension providers should be able to request the appropriate tax code in advance of making any payment, the technology is there to do this kind of thing.”

Selby added: “The government needs to urgently review this policy – it is manifestly unfair to lumber savers who are using the freedoms in the way the Government intended with whopping great tax bills.”

How to reclaim your money

If you’ve been overcharged tax on your defined contribution pension, you may need to fill in one of the three claims forms which can be found on the government’s ‘Claim a tax refund’ page.

These forms include:

  • P55 – used by claimants when the payment didn’t use up the pension pot and individuals aren’t taking regular payments. It can only be used if a pension provider can’t refund you. HMRC received 8,489 claims in Q3.
  • P53Z – used by claimants where the payment used up your pension pot and you have other taxable income. HMRC received 5,944 claims in Q3.
  • P50Z – used by claimants if the payment used up your pension pot and you have no other income in the tax year. HMRC received 1,735 claims in Q3.

Or it is possible that your pension provider may pay you back automatically.

Otherwise HMRC may post you a P800 tax calculation, usually by the end of September where you may be able to claim online or it will send you a cheque.