Pensions: Tax overpayment of £1bn prompts reform call

People who have flexibly withdrawn pension savings have collectively, temporarily, overpaid more than £1bn in tax, new figures show.

Pensioners are initially charged an emergency tax code after taking money from their pension pot, before having to wait for a refund from HM Revenue and Customs (HMRC).

Another £160m was repaid last year, so the total since 2015 has topped £1bn.

Pensions experts have called for the system to be reformed.

“This is an absolute disgrace. A system based on systematic over-taxing of pension savers cannot be right,” said Sir Steve Webb, a former pensions minister and now a partner at consultants LCP.

“There is no good reason why citizens who access their pension should have to go through the hassle of claiming back excess taxation which they should never have had to pay in the first place.”

Changes to the pension system in 2015 allowed people to withdraw some of their defined contribution pension savings as an income from the age of 55, while leaving the remainder invested.

In doing so, some are charged at an emergency tax rate, which means they could temporarily pay thousands of pound more in tax than they actually owe.

To reclaim the overpaid tax, they need to complete one of three HMRC forms, which should mean money is returned within 30 days.

If they fail to do so, then they rely on HMRC reviewing the payments, possible after receiving a self-assessment tax return, and making a refund. The tax authority will work out their annual tax bill at the end of the tax year as part of the usual reconciliation exercise.

Sir Steve said that, although people would not be permanently out of pocket, it could be many months before someone’s financial situation was corrected.

The form you need to fill out will depend on how you have accessed your retirement pot:

Source: AJ Bell

The forms and online service can be found via the gov.uk website.

More independent information and guidance about pensions is available from Pension Wise.

The latest HMRC figures show that more than £48m was repaid to 15,856 people in overpaid tax on flexible withdrawals in the first three months of the year. Although the tax system differs in Scotland, the same scenario could arise.

The ongoing situation should be changed, according to those in the pension sector.

“It is a scandal that government has failed to adapt the tax system to cope with the fact Britons are able to access their pensions flexibly from the age of 55, instead persisting with an arcane approach which hits people with an unfair tax bill, often running into thousands of pounds,” said Tom Selby, from investment platform AJ Bell.

Andrew Tully, technical director at pensions firm Canada Life, said “a better way” needed to be found, but said the current system allowed for a workaround for some people.

“A good tip for those customers making a pension withdrawal for the first time, is to initiate a small withdrawal of say £100. That will generate a tax code from HMRC which the pension provider will apply to any subsequent withdrawals,” he said.

“That will result in the tax being taken at source being far more accurate in many more cases, not only reducing the burden of paperwork but equally importantly the customer receiving a more accurate withdrawal in the first place.”

A spokesman for HMRC said: “Nobody overpays tax as a result of taking advantage of pension flexibility. We will automatically repay anyone who pays too much because they are on an emergency tax code. Individuals can claim back any overpayment earlier if they wish.”

The tax authority said that the alternative – for some people to pay too little tax and then be pursued for the money – would be undesirable and inappropriate if people had a relatively low income.