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The £1bn pension tax ‘scandal’: Check if you’re owed cash from HMRC

Paloma Kubiak
Written By:
Paloma Kubiak

Pension savers overpaid £33m in tax in the three months to September. But in total, the amount could stand closer to £1bn. Here’s how to check if you’re affected, and how to get your money back.

Between July and September 2022, HMRC processed just under 10,000 pension tax reclaim requests, with the total value repaid standing at £33m.

This is slightly lower than the £33.6m repaid in the previous quarter.

But since the dawn of pension freedoms in 2015, a staggering £925m has now been clawed back by savers after being overcharged the tax by HMRC.

However, as the HMRC statistics only capture the total repaid from people who have actively reclaimed their money, the true figure in overcharged tax could be higher.

And according to Steve Webb, partner at pension consultancy Lane, Clark & Peacock, and former pensions minister, some people who do not fill in a claim form – or do not know they have to do so – may only get a refund when they eventually fill in a tax return possibly over a year later.

He added that no figures are available for the amounts refunded through this route, “but it is likely that the total amount of overpayment will be well over £1bn since the system began”.

Why are pension savers overcharged 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 defined contribution pension (over £10,000 and over the 25% tax-free lump sum), providers apply tax on a ‘month one’ or ‘tax at source’ 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.

The emergency tax rate applied is usually calculated on a much higher annual withdrawal than the pension saver actually takes.

As such, due to the nature of this tax anomaly, pension savers actively need to reclaim the tax owed and to date, some 270,000 forms have been filled.

‘Quiet scandal’

Webb, added: “It remains a quiet scandal that tens of thousands of people every year have to fill in forms to get back tax from HMRC which they should never have had to pay in the first place.

“It may be convenient for HMRC to overtax people and then force them to fill in forms to get their money back, but it is hardly putting the customer first. A much simpler system would be for tax to be deducted at the basic rate with adjustments for those who may pay tax at a different rate, including through the annual tax return process. It is time for this scandal to end.”

How to reclaim overpaid tax

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 6,759 claims in the three months to September 2022.
  • P53Z – used by claimants where the payment used up your pension pot and you have other taxable income. HMRC received 2,119 forms.
  • P50Z – used by claimants if the payment used up your pension pot and you have no other income in the tax year. HMRC received 1,078 claims.

It is possible that your pension provider may pay you back automatically. Otherwise HMRC may post you a P800 tax calculation where you may be able to claim online or it will send you a cheque.

How to avoid overpaying tax on your pension in the first place

According to Andrew Tully, technical director at Canada Life, one work-around for people making a pension withdrawal for the first time, is to initiate a small withdrawal of say £100.

Tully said: “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.”