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Pension savers reclaim £33m in overpaid tax: Are you owed money?

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A ‘clunky system’ means people tapping into their pension savings are hit with emergency tax they then must reclaim. The figure for the three months to June stood at £33.6m.

Between April and June 2022, HMRC processed just over 10,000 pension tax reclaim requests, with the total value repaid at £33,689,819.

This is a 50% increase on the Q1 2022 figure and means HMRC processed 3,000 more claims this quarter than last.

Since the dawn of pension freedoms in April 2015, a staggering £891m 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.

Why are pension savers charged too much 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.

Jon Greer, head of retirement policy at Quilter, said the increase in people accessing their pension funds comes as the cost-of-living crisis intensifies, with this “clunky system resulting in it taking much longer for them to access their full pension withdrawal”.

He said: “This emergency tax situation can be particularly frustrating for people trying to access their funds quickly, particularly if they don’t understand why it has happened. It arises due to an oddity of the PAYE system when people start to take money from their pension.”

Just yesterday, the government confirmed it would “correct the injustice” of another pension tax anomaly relating to a ‘net pay arrangement’ and ‘relief at source’ scheme when it comes to the way pension contributions are treated for low earners. However, for now at least, it appears that the tax first and reclaim later method will continue.

Andrew Tully, technical director at Canada Life, said: “The latest HMRC numbers just re-emphasise how complex the tax position around pension withdrawals is. Seven years on from the introduction of the pension freedoms there must be a better way to administer the tax position around pension withdrawals which would mean HMRC is not processing refunds of over £33m in just a three-month period, and close to £900m since 2015.”

Tully added that a ‘work-around’ does exist for pension savers to avoid being hit with the emergency tax.

“For customers making a pension withdrawal for the first time, initiate a small withdrawal of say £100. That will generate a tax code from HMRC which the pension provider will apply to any subsequent withdrawals. That will result in the tax being taken at source being far more accurate in many more cases, reducing the paperwork but equally importantly the customer receiving a more accurate withdrawal,” he explained.

How to reclaim your money

Greer explained that HMRC will make a repayment automatically, but “ given that could take time to be processed it is best to make a repayment claim yourself to avoid waiting”.

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 7,345 claims in Q1.
  • P53Z – used by claimants where the payment used up your pension pot and you have other taxable income. HMRC received 1,746 claims in Q1.
  • P50Z – used by claimants if the payment used up your pension pot and you have no other income in the tax year. HMRC received 927 claims in Q1.

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.

Greer added: “Working alongside a professional adviser who knows and understands the system will reduce the risk of more tax being handed to the tax man upfront. For example, it is possible to make multiple smaller pension withdrawals, rather than one lump sum, to ensure the majority of the withdrawal uses an up to date tax coding, which means you won’t be emergency taxed on the full amount.”

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