HM Revenue and Customs (HMRC) has released data on how much pensioners were overtaxed on their first pension freedoms withdrawal of the tax year.
Over 10,000 reclaim forms were processed in Q1 2020 and the average person received a refund of £3,141, with the total hitting nearly £33m for the quarter and a record £166m ($207.8m, €190.7m) during the 2019/20 financial year, according to figures provided by Canada Life.
Data show £600m has been reclaimed from HMRC since 2015.
This comes as pension freedom withdrawals hit the £35bn mark on its fifth anniversary.
Sting in the tail
Andrew Tully, technical director at Canada Life, said: “Beware of the sting in the tail if you are considering using your pension as a cash machine. Any withdrawals over your 25% tax-free allowance are taxed as income.
“However, HMRC often require the first withdrawal to be taxed at the emergency rate, which normally means too much tax is deducted. This can catch people out, for example those who are planning to use the withdrawal for a specific purpose and haven’t factored in the tax that is due.
“The whole system is complex and there is a clear need to review how it works in practice given we are now five years into the freedoms.”
Tax codes
Under the pension freedom rules, people aged 55+ can access their retirement pot and enter drawdown, with any withdrawals above the 25% tax free sum taxable at an individual’s marginal rate of income tax.
In some cases, the pension provider will already have a tax code for the retiree, if the saver has previously withdrawn money from their pension during the tax year.
But where it does not have the correct tax code for the individual, withdrawals are taxed using a higher rate emergency tax code.
Covid-19 issues
People dipping into their pensions for the first time as a result of coronavirus risk getting thousands of pounds less than expected due to HMRC’s emergency ‘month 1’ taxation policy on single withdrawals.
Tom Selby, senior analyst at AJ Bell, said: “Anyone planning to access their pension in the new tax year, including those looking to use their retirement pot to plug an income gap resulting from covid-19, needs to be aware of the impact month 1 taxation will have on the amount of money they receive initially.
“For those taking a regular stream of income, HMRC should automatically adjust your tax code so you receive the right amount in subsequent months.
“However, where you are making a single withdrawal in the tax year you will either have to fill out one of three forms or wait for the revenue to sort out your tax position.”
Those forms are the P55, P53Z and P50Z.
