The amount of ’emergency tax’ recovered by people taking money out of their pension pots has exceeded £1bn.
Since the pension freedom reforms were introduced in 2015, HMRC charges additional tax on any initial amount withdrawn from a fund, assuming it could be the first month of a series over the remainder of a tax year.
In a system that critics call an ‘absolute disgrace’ and ‘a scandal’, pension savers then have to claim their money back from the tax authorities themselves or wait for it to be settled after the end of the current tax year.
Pension savers have so far been charged £1bn in emergency tax on withdrawals – which they then have to claim back or wait for the IRS to settle next year
New figures announced today by HMRC show that recoveries of overpayments amounted to £48.5 million in the first three months of 2023.
That’s up from £22m at the same time last year as more people draw on their pensions to make ends meet as household bills rise – and the total recovered since 2015 now stands at £1.02bn.
> How to get YOUR pension money back: Find out below
News from the government that tax refunds now exceed £1bn sparked renewed protests from pension experts who believe this is an unfair burden on savers.
Former Pensions Secretary Steve Webb says: ‘This is an absolute disgrace. A system based on systematically overloading pension savers cannot be right.
“There is no good reason why citizens with access to their retirement should bother trying to recover excess tax they should never have paid in the first place.
“And we’re not talking small amounts of money, with over £1bn paid back by HMRC to date.”
This huge increase in the number of claims forms processed shows that people still need access to their pension funds despite the rising cost of living
Webb, a partner at LCP who is also a columnist for This is Money’s pensions, says: “The system is long overdue for reform so that it benefits pension savers and not the Treasury.”
Tom Selby, head of pensions policy at AJ Bell, says the figure is ‘astonishing’, adding: ‘It is a scandal that the government has failed to adapt the tax system to the fact that Britons have flexible access to their pension of 55 years.’
He accused the government of “continuing a secretive approach that saddles people with an unfair tax bill” by requiring them to fill out one of three forms if they want to get their money back as soon as possible.
“Lower income earners who are less familiar with the self-assessment process are less likely to go through the official process to recover the money they owe. As a result, they will trust HMRC to put their affairs in order.’
Andrew Tully, technical director at Canada Life, says: ‘Eight years after the introduction of the pension freedoms, there needs to be a better way to manage the tax position around flexible pension withdrawals, which would mean HMRC not processing refunds in the amount of £. 1 billion.
‘A good tip for customers taking out a pension for the first time is to make a small withdrawal of, say, £100.
‘That generates a tax code from HMRC which the pension provider will apply to any subsequent withdrawals.
“That will result in the tax charged at source being much more accurate in many more cases, not only reducing the administrative burden, but equally importantly, the customer will receive a more accurate record in the first place.”
Jon Greer, head of pension policy at Quilter, says of the restitution figures for the beginning of this year: ‘This massive increase in the number of claims forms processed demonstrates the continued need for people to access their retirement funds amid the growing cost of living crisis impacting day-to-day financial situations.
“Unfortunately, this system leads to long waits before people receive their full expected amount at a time when they need it more than ever.”
“This system clearly needs to be rethought, as these ever-increasing numbers do not indicate a process that is working properly.”
A spokesman for HMRC says: ‘No one is paying too much tax by using pension flexibility.
“We will automatically refund anyone who pays too much because they have an emergency tax code. Private individuals may be able to reclaim any overpayment earlier.’
If you do not apply directly to HMRC for a refund, it will work out your annual invoice at the end of the tax year as part of its usual reconciliation exercise.
What is the ’emergency tax’ pension trap – and how do you get your money back?
When you make a first withdrawal from a defined contribution pension pool, HMRC assumes it will be the first of many over the remainder of that tax year, which could put you in a higher tax bracket than usual.
It is therefore applying an emergency tax rate on the basis that this could only be the first in a series of withdrawals.
Retirees get caught if they make a one-off large initial withdrawal, or if they plan to withdraw smaller regular or ad-hoc amounts afterwards.
The withholding tax can be particularly onerous if you make a withdrawal in April, at the start of a new tax year, and do not schedule any further withdrawals.
To get back overpaid tax as quickly as possible, you can do this with one of the following three forms
P50Z – if the benefit has used up your pension pot and you have no other income in the tax year
P53Z – if the benefit has used up your pension pot and you have other taxable income
P55 – if you have only withdrawn part of your pot and you are not making regular payments.
If you don’t claim proactively, you should get a refund through your tax return after the end of the current tax year, although it can take a long time.
Retirement experts suggest making smaller withdrawals and spreading them out so you’re taxed correctly at the start of retirement rather than having to recoup overpayments later.
> Read our guide on urgent taxation of pension withdrawals
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