Since the introduction of 2015’s pension freedoms, hundreds of thousands of savers have overpaid tax on their retirement savings by more than £300m, new data from HM Revenue & Customs (HMRC) has shown.
HMRC repaid around £22.5m to savers during the first three months of 2018 alone. Some 116,000 people have reclaimed overpaid tax since 2015, but thousands more could be owed money.
Find out why so many people are being overtaxed on their pensions and how to reclaim your money if you think you’ve been affected.
Why are pensions being overtaxed?
The pension freedom rules allows pension savers over the age of 55 to withdraw money from their pension pots however they like. They can even withdraw all of their savings in one go, if they wish.
There are two principle ways to do it. You could take an ‘uncrystallised fund pension lump sum’ (UFPLS). With these kinds of withdrawals, 25% is paid tax-free and the remaining 75% is subject to income tax.
Your pension company collects the tax on your behalf, the lump sum you get is paid net of tax. However, when you make your first withdrawal, you’re likely to be taxed on an ’emergency rate’.
This is because your pension company doesn’t know what your tax code is, or details of your other income, if you have any.
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. A £10,000 withdrawal could see you end up being taxed as though your annual income is £120,000.
We’ve explained how this works, and how much extra you could lose, in this story.
This can often go unnoticed by savers, meaning that they lose significant sums of retirement income to tax that isn’t owing.
Find out more: what can I do with my pension pot?
Average overpaid tax refund of £2,400
Pension freedoms were introduced in April 2015, and since that date HMRC has refunded around £305m in overpaid tax from pension savings.
More than 10,000 people have claimed back overpaid tax on pensions just in the last quarter, with the average claim coming to £2,400.
The total number of people who’ve been forced to reclaim overpaid tax on their pension since 2015 is now 116,784.
The figures, however, represent the tip of the iceberg – as they only include those people who have reclaimed their money.
Insurer Royal London, headed up by former pensions minister Sir Steve Webb, has warned that the true amount of overpaid tax on pensions could be significantly higher.
Mr Webb has labelled the process of reclaiming tax in this way ‘draconian’.
What to do if your pension is overtaxed
If you’re planning to make a pension withdrawal, make sure to check your tax liabilities carefully – both for the months you made the withdrawal, and the subsequent months.
If you find that you’ve overpaid tax on your pension, you will need to fill out one of three claims forms.
A P55 form should be used if you haven’t withdrawn your entire pension pot and are not taking regular payments either. HMRC received 6,218 claims from savers in this situation in the first quarter of the year.
If you have withdrawn your entire pension pot and also receive other taxable income you will need to complete a P53Z form. Around 3,448 claims of this nature were made in the first three months of 2018.
The P50Z form should be used if you have drawdown your entire pension pot but have no other taxable income. This type of claim received the lowest amount of applicants with only 988 sent to HMRC since the beginning of the year.
All of the forms can be found on the government’s claim a tax refund page.
In some cases, HMRC will post you a P800 which includes your tax calculation for the year and identifies where you might have overpaid on pension income.
Is pension drawdown right for you?
The new pension freedoms offer savers more flexibility and control over how their retirement income is managed. But before you start dipping into your pot, there are some considerations to bear in mind.
You may explore income drawdown if you want to have more control over the way your money is invested. It might also be convenient if you want the flexibility of taking out different sums during the year and managing your annual tax liability.
But income drawdown may not be the best option if you want a guaranteed level of income each year. It may also not work for you if you’re concerned about running out of money or don’t want to expose your pension pot to investment risk.
Your retirement savings need to last you a lifetime – so before you make a decision, ensure you fully understand the consequences and seek qualified financial advice.
For more information, take a look at our guide on income drawdown and check out the short video below.