Five things to know before accessing pension freedoms

During the first bear market since they were introduced

Your first taxable withdrawal will be subject to emergency ‘Month 1’ taxation.

“Since the pension freedoms launched in April 2015, well over £500m has been repaid to savers who were overtaxed on taxable withdrawals,” Selby added.

“When you first take a flexible payment from your pension, HM Revenue & Customs (HMRC) will automatically tax it on an emergency ‘Month 1’ basis.

“This means that the usual tax allowances are divided by 12 and then applied to that first withdrawal.

“For example, if someone made a £12,500 taxable withdrawal in 2020/21 and had no other taxable income, they might expect to be charged 0% income tax as the withdrawal is within their personal allowance.

“However, because it is their first taxable withdrawal only £1,042 (£12,500 personal allowance divided by 12) is taxed at 0%. The next £3,125 (£37,500 basic-rate tax band divided by 12) is taxed at 20%, with the remaining £8,333 taxed at 40%.

“In total, rather than paying zero tax they would face an initial – potentially shocking – bill of £3,958.

“For those taking a regular income this shouldn’t be a problem, as any overpaid tax in the first month will be ironed out via your tax code.

“However, where it is a single payment over the tax year there are two options – wait until the end of the tax year for HMRC to hopefully sort it out, or sort it out yourself by filling out one of three forms: [P50Z, P53Z or P55].

“Once you’ve filled out and sent off the relevant form, HMRC says you should receive a refund of your overpaid tax within 30 days.”

Tags: AJ Bell | Covid-19 | Pension Freedoms | Tom Selby