Brits have overpaid almost £1billion of tax on pension withdrawals due to a “scandalous” quirk in the rules, and the amount is climbing by a staggering £15million every money.
The average overpayment is now £3,141 and while savers may eventually get this money back the system is slow and complicated.
This only adds to cost-of-living crisis pressures, as savers often have to wait until the end of the tax year to get a refund.
They face an anxious wait for redress as they also depend on HMRC getting their sums right.
New HMRC data shows that savers have reclaimed a total of £970million in overtaxation since 2015’s pension freedoms allowed the over-55s to make flexible cash withdrawals from their pensions.
Tax repayments hit a record £45million between October and December, the highest for the final quarter with 14,355 claiming.
As surging inflation eats into people’s spending power, savers are raiding retirement pots to make ends meet, said Tom Selby, head of retirement policy at AJ Bell.
They withdrew £33.6billion between April and June last year, up a quarter on the previous year.
This is now filtering through into pensions overtaxation figures, which will “inevitably” pass £1billion this year, he said.
Selby said the true figure is actually a lot higher as many of those who have been overtaxed do not go through the official process of reclaiming the tax they are owed, but rely on HMRC putting things right for them.
Many will be on lower income incomes who are less familiar with the self-assessment tax return process, Selby added. They cannot afford to wait for money that is rightfully theirs.
“It is scandalous that the Government has done nothing to address this issue almost eight years since pension freedoms were introduced,” Selby said.
Savers who draw regular monthly income from their pension do not need to take action, as HMRC will adjust their tax code to ensure they are paying the right amount.
However, those who make a single lump sum withdrawal are treated as if they were going to carry on taking that sum every single month for the rest of the tax year.
The first flexible withdrawal of the tax year is taxed under something called a ‘Month 1’ emergency tax code, which divides the normal tax allowances by 12 and applies them to the first withdrawal. “Those taking a one-off lump sum are likely to pay far too much tax as a result,” Selby said.
Many do not realise they are going to be automatically overtaxed until they faced with a shock tax bill often running into thousands of pounds.
READ MORE: Drawdown warning as HMRC grabs 40% of retirement savings
It is possible to get your money back within 30 days, but only if you fill out one of three HMRC forms to reclaim your money, Selby said. “If you don’t, you are left relying on the efficiency of HMRC to repay you at the end of the tax year.”
Which form you use depends on how you accessed your money.
Use P50Z if the payment used up your pension pot and you did not work or receive benefits that tax year. Form P53Z is for those who used up their pension and are working or getting benefits. Those who flexibly accessed just part of their pot should complete form P55.
Otherwise claim the money back through your self-assessment tax return.
Canada Life technical director Andrew Tully said there must be a better way to administer the tax position around pension withdrawals, and HMRC needs to take a fresh look at its policy.
He suggested a work around for those making their first pension withdrawal. “Start by taking a small sum of, say, £100. That will generate a tax code from HMRC which the pension provider will apply to any subsequent withdrawals.”
This way tax taken at source will be far more accurate. “It also cuts out unnecessary paperwork,” Tully added.
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