How can I avoid paying ’emergency tax’ to HMRC on a pension withdrawal? Steve Webb replies

I have a drawn pension worth £84,000.

In December 2023 I will be 74 and my husband is 72.

This tax year I would like to take home 25 percent tax-free cash.

My total income from a current company pension and state pension is approximately £30,000 per year.

So in addition to taking 25 percent tax-free cash, I plan to take an additional lump sum of the withdrawn pension this tax year so that I only pay 20 percent tax up to my annual benefit limit of £50,270.

In other words, this would be an extra £20,000 at 20 percent tax.

However, my pension company informs me that they will apply an emergency tax code to this £20,000 and that I will then have to reclaim the excess tax paid from HMRC.

My question is: Can I request HMRC to advise me/my pension company before I take the £20,000 that only 20 per cent tax is due, which will require even more effort in communicating with HMRC to get me the excess refund taxes paid for this tax year?

Is there a standard template I can use to contact HMRC about my intentions, as above?

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Steve Webb replies: The issue you raise relates to how HMRC chooses to collect tax when someone accesses their pension pot.

In your situation, where you have an annual income of €30,000 and choose to take €20,000 of taxable cash out of your pension, you would think that you only have to pay the basic rate of tax on all this, because you are below the threshold of € 50,270 is for paying your pension. higher income tax.

And this is indeed where you will end up. But unfortunately, you’ll have to jump through some hoops to get there.

The problem is that even though you know you only want to withdraw £20,000 once in the current tax year, HMRC won’t.

From their point of view, you could plan to withdraw this amount multiple times, and this would obviously give you a higher tax rate.

If they only deducted the basic tax, they would worry that they taxed you too little and then have to find a way to get the extra tax.

The way HMRC deals with this is by expecting your pension provider to apply an ’emergency’ tax code.

This does not take into account your other income, but assumes that you will make multiple withdrawals and that you will be (over)taxed accordingly.

To get your money back, you must then complete the relevant form or claim online: Claim tax back on a flexibly accessible overpaid pension benefit (P55).

As you will see, if you choose to fill out a form, you must choose the correct form. These are:

– Form P55 if you have had flexible access to your pot, but have not emptied it, and do not intend to make any further such withdrawals;

– Form P53Z if you have flexible access to your pot and have emptied it;

– Form P50Z if you have flexible access to your entire pot and you have stopped working.

If you fail to do any of these things, any refund due will be issued through the year-end tax assessment process.

As you rightly say: this is all a bit nonsense. I have repeatedly complained that HMRC routinely overcharges people and then expects them to claw back their own money.

Since this system was first introduced in the wake of the ‘pension freedoms’ legislation, HMRC has had to pay back as much as £1.1 billion for around 400,000 pension withdrawals.

This system is causing major disruption to people and is all about the convenience of HMRC and not the taxpayer.

However, there is a possible ‘work around’ that could largely solve this problem.

Instead of making a single withdrawal of €20,000, consider making a (very) small withdrawal first. Although an emergency tax code will be applied to this small withdrawal, this should then result in HMRC providing a regular tax code to your pension provider.

They can then apply this to your main withdrawal and you should not be charged too much for this.

As for the amount we are talking about, a lot depends on the rules of your withdrawal scheme. Some providers have a minimum withdrawal amount (e.g. €1,000), some charge for each withdrawal and others only allow a certain number of withdrawals per year.

But in principle it should be possible to split your withdrawal into an initial nominal amount and then a subsequent main withdrawal. And if all goes well, this should mean that you can largely avoid becoming overloaded.

Of course, it would be better if you didn’t have to go through this somewhat artificial procedure to avoid becoming overloaded in the first place!