Thousands of people who’ve taken big lump sums from their retirement savings could be failing to reclaim huge tax refunds.
When you take a lump sum from your pension for the first time, your pension company will automatically deduct tax through the PAYE system. And as it doesn’t know your tax code, it will tax you as if the lump sum you’re withdrawing is your monthly income.
So, if you were taking £20,000 out of your pension, you’d be taxed as if you earned whopping £240,000.
Research from AJ Bell, a pension company, suggests that tens of thousands of people may not be aware they’re paying far more than they should. It found that, on average, around 11,000 refunds per quarter have been paid out since 2015, compared to the average 139,000 pension pots being accessed every three months.
How is my pension taxed?
Any withdrawals you take from your pension are taxed under income tax rates. For the 2017/tax year:
- You pay no tax if your total income is below £11,500
- You pay 20% if your total income is between £11,501 and £45,000
- You pay 40% if your total income is between £45,001 and £150,000
- You pay 45% if your total income exceeds £150,000
There are a number of ways you can take money from your pension. One way is to take an ‘uncrystallised fund pension lump sum’, or UFPLS. With these kinds of withdrawals, 25% is paid tax-free and the remaining 75% is subject to income taxe.
The other way is to take a lump sum from flexi-access drawdown, all of which is subject to income tax.
However, if you’re doing this for the first time, your pension company is unlikely to know your tax code, and how much income you have from other sources. So, tax is calculated on what is known as a ‘Month 1’ basis, meaning you’ll be taxed as though the lump sum you’re drawing will be repeated every month.
The table below shows how much more tax a basic-rate taxpayer could be paying.
|The size of your lump sum||How much tax a basic-rate taxpayer would pay (if they had no other income)||How much tax you’d paid under the ‘Month 1’ system|
Data sourced from AJ Bell.
How can I reclaim overpaid pension tax?
Overpayments will eventually be refunded by HMRC, but the process could take months, unless you actively claim a refund, in which case it should take no more than four weeks.
Use one of three online forms to do this. These can be found by visiting gov.uk.
- P50Z For people who withdraw their entire pension fund and have stopped working.
- P53Z For people who withdraw their entire pension pot but are still working.
- P55 For people who withdraw part of their pension pot as a lump sum but not all of it.