Thousands of pension savers have been overtaxed on pot withdrawals due to HMRC’s outdated system, with £57m reclaimed in the three months to 30 June, figures reveal.
A total of £56.9m was repaid to individuals enjoying pension freedom pot withdrawals, after 16,000 claim forms were processed in the second quarter of 2024.
This averages at £3,540 per saver, almost £400 more than the figure in Q1. It is also the third-highest average figure on record.
However, in total, since the dawn of pension freedoms in 2015, almost £1.3bn has now been reclaimed by people overtaxed when withdrawing their retirement cash.
Pension freedoms allow anyone over the age of 55 (57 from April 2028) to access their pension pots, with the first 25% being tax-free.
However, when someone takes their first and single ‘flexible’ withdrawal from their defined contribution pension, providers apply tax on a ‘month one’ basis.
This means the withdrawal is counted as if the same amount of money will be taken every month during the financial year, rather than viewing it as a one-off withdrawal.
The emergency tax rate applied is usually calculated on a much higher annual withdrawal than the pension saver actually takes, meaning shock tax bills for many – and the need to reclaim tax later down the line.
‘Simply unacceptable’
Jon Greer, head of retirement policy at Quilter, said not only do the rising figures suggest more people are still reliant on their pension pots, but the overtax system also “presents a significant issue for those hoping to access funds quickly”.
Greer said: “The rising number of claimants represents a large [number] of people being overtaxed and waiting unnecessarily for their funds due to a clunky system that is in much need of reform.
“There is a major flaw within the PAYE system in that while it works for regular income, the way pensions can be taken does not align with the system’s design, and as a result retirees have been heavily impacted since pension freedoms were introduced in 2015.”
Tom Selby, director of public policy at AJ Bell, said the true overtaxation number will likely be substantially higher.
“In particular, people on lower incomes who are less familiar with the self-assessment system might be less likely to go through the official process of reclaiming the money they are owed. As a result, they will be reliant on HMRC putting their affairs in order.
“It is simply unacceptable that, almost a decade on from the introduction of the pension freedoms, the Government has failed to adapt the tax system to cope with the fact Brits are able to access their pensions flexibly from age 55, instead persisting with an arcane approach [that] hits people with an unfair tax bill, often running into thousands of pounds, and requires them to fill in one of three forms if they want to get their money back within 30 days.”
How to reclaim your overtaxed pension money
It is possible to get your money back within 30 days if you fill out one of three HMRC forms, otherwise it will be repaid at the end of the tax year.
Which one you need to fill out depends on how you accessed your retirement pot:
- 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 11,449 claims in the three months to 30 June 2024.
- P53Z – used by claimants where the payment used up your pension pot and you have other taxable income, such as if you’re working or receiving benefits. HMRC received 3,612 forms.
- P50Z – used by claimants if the payment used up your pension pot and you have no other income in the tax year (not working or receiving benefits). HMRC received 1,018 claims.
If you’re taking regular income via drawdown or making multiple withdrawals, then you shouldn’t need to take any action, as HMRC should adjust your tax code to ensure the correct amount is collected.
But to prevent having to fill out forms and reclaim your cash, Selby shared this tip to avoid overtaxation:
“One way savers planning to take a single withdrawal in a tax year can potentially avoid the shock of a big overtaxation bill is by taking a notional withdrawal first. This should mean HMRC is able to apply the correct tax code to the second, larger withdrawal.”
