HMRC overtaxing pensioners who dip into their retirement savings

Retirees pay too much tax when they dive into their retirement savings.

This ‘silent scandal’ is only expected to get worse as more older savers pull money out of their pension pots to cope with the rising cost of living.

And experts are now calling on HM Revenue & Customs (HMRC) to urgently rethink the way withdrawals are taxed.

Due to the pension freedom rules of 2015, savers no longer have to purchase an annuity (an income for life) and they can deposit into their pension fund.

People over 55 can withdraw a quarter of the money as a tax-free lump sum. Anything above that is taxed at their usual rate.

But HMRC treats lump sum payments as if they were a permanent increase in income and applies an emergency tax code.

As a result, savers have been overburdened to the tune of £892 million since 2015, AJ Bell analysis of HMRC data reveals.

You can get a tax refund within 30 days if you fill out a form. Otherwise you will have to wait until the end of the tax year.

According to figures from the HMRC, more than £33 million was paid back between April and June this year to more than 10,000 people who overpaid in tax on taking pensions.

The average refund was £3,363.

Steve Webb, former pensions minister and partner at consultants LCP, said: ‘It is outrageous that HMRC overcharges thousands of people every month and expects them to fill out a form to get their own money back. HMRC urgently needs to reconsider its approach.’

The problem is that tax is collected through the Pay As You Earn (PAYE) system, which is designed to tax your monthly income, rather than one-time payments.

This means that HMRC assumes that you will receive the same amount each month.

For example, if you have a regular income of £15,000 and take out a fully taxable amount of £10,000 from your pension pot, you should be taxed on £25,000.

Usually you don’t pay tax on the first £12,570 of your income, the so-called personal deduction, and then 20 percent base tax on the next £12,430.

This equates to € 2,486. So you paid £2,000 tax on the lump sum and £486 on your usual £15,000 income.

Instead, under the HMRC system, people over 55 end up paying a higher tax rate on more than half of their withdrawal.

With a flat fee of £10,000 you pay no tax on the first £1,047 – the equivalent of a month’s personal deduction (£12,570 divided by 12).

You will then pay 20 percent base rate tax on the next £3,141 (the base rate supplement of £37,700 divided by 12), which amounts to £628.

Then you would pay 40 percent on the remaining £5,812, which is £2,324.

Your total tax bill for the lump sum pension is £2,952 – an additional £952.

Use Form P55 to reclaim emergency tax if you have withdrawn part of your pension pot and are not taking any fixed income.

sy.morris@dailymail.co.uk