HMRC’s recent data shows that pensioners have collectively been overcharged a total of £400 in the last four years. This shocking figure is a result of how the new pension rules, announced in the 2015 Budget, are being administered.

How has such widespread overcharging happened?

In 2015, pension rules changed so that people aged 55 and over do not have to purchase an annuity, but can withdraw money from their pension savings pots as they want. This can be as a whole lump sum, or just a particular amount.

Which? reports that £23.6bn has been drawn down from pensions since the rule change. 448,000 pensioners withdrew £6.13bn in just the last half of 2018.

The problem arises with the way tax on this drawn down money is calculated and collected. There are two ways to access your pension pot money:

  • Pension Drawdown Plan: Your first 25% is tax free and any further withdrawals are liable for income tax.
  • Uncrystallised Fund Pension Lump Sum: 25% is tax free and the rest is subject to income tax

This all makes sense and is what pensioners are expecting when they access their pension funds in these ways. The problem arises with who is collecting the tax. Your pension company pays you your lump sum ‘net of tax’, meaning that they have already deducted tax before you get it. Now they don’t know if you have any other income, or even what your tax code is, so the first withdrawal you receive is usually ‘emergency taxed’.

The pension tax overpayment problem

This is also called ‘Month 1’ taxation because the calculation assumes that this is the first of 12 regular payments your will get every month. Obviously, you are only receiving one lump sum payment, not a monthly pay out. So if you take out £10,000 from your pension pot, you will be taxed as if you earn £120,000 annually.

This is definitely not the real tax liability for pensioners in this position. It is easy to miss the fact that you have been overtaxed in this way because a third party, your pension provider, is dealing with the tax payment to HMRC. But this is a massive amount of money to overpay.

Don’t HMRC refund this incorrect pension tax?

Yes HMRC do refund this tax overpayment and the current total of pension tax refunds since 2015 is £402,743,108. That’s 174,260 claims. Imagine how many pensioners haven’t reclaimed their pension tax overpayment.

The average claim of 14,000 people in the last three months of 2018 was £2,161. We’re talking about substantial amounts here.

Is this an acceptable situation?

The current pension tax situation does seem to be extremely onerous for the taxpayer.

Sir Steve Webb is a former pensions minister and, as reported by Which?, said: “It is outrageous that HMRC’s approach is to tax first and ask questions afterwards. Since the system started in 2015, more than 170,000 people have had to fill in forms to claim back tax they should never have had to pay. There are ways to get around the system, such as making a small initial withdrawal which should trigger HMRC to issue a tax code which can then be applied to larger withdrawals. But all of this adds delay and inconvenience. The system should be run for the convenience of taxpayers, not the convenience of HMRC.”

How do I reclaim my pension tax overpayment?

If you think that you have overpaid on your pension tax, then there is a system to reclaim it from HMRC. You will need one of three possible forms, depending on your situation:

  • P50Z: if you took your whole pension pot and you have no other taxable income
  • P53Z: If you took your entire pension pot and you have other taxable income
  • P55: If you only took part of your pension pot and you are not receiving regular pension payments

If you are not sure if you should draw down any of your pension, or how to reclaim your pension tax overpayment, it is sensible to seek the advice of a fully qualified tax expert or accountant.