Hundreds of thousands of pension savers have been refunded £716m in tax since the pension freedoms were introduced in 2015, according to the latest data published by HMRC.
The pension rules introduced six years ago aimed to give people more control over their retirement income, allowing pension savers who have reached the age of 55 to withdraw money from their pots whenever they like.
Since 2015, the total value of flexible withdrawals from pensions has exceeded £45bn. But those who withdraw for the first time are in danger of being charged excessive amounts of tax at an ’emergency rate’, so could be entitled to a refund from HMRC.
Here, Which? explains why HMRC is overcharging pension tax and how you can claim a refund if you’ve been affected.
How people are using the pension freedoms
Under the pension freedoms rules, savers who have reached the age of 55 are no longer required to purchase an annuity and can withdraw from their pension in small amounts or as a lump sum.
In the three months to March 2021, £2.6bn was withdrawn from pensions flexibly. This represents a 6% increase year-on-year from £2.5bn withdrawn throughout the same months in 2020.
The number of people who withdrew money from their pensions has also increased in the same period.
Around 383,000 people withdrew from pensions in the three months to March 2021, a 10% increase (from 348,000) compared to January to March 2020 – and a 6% increase compared to the previous three months (October to December 2020) which saw 360,000 withdraw.
The average amount withdrawn decreases
However, the average amount withdrawn per individual throughout January, February and March 2021 was £6,800, a drop of 4% from £7,100 during the same months in 2020.
AJ Bell senior analyst Tom Selby says last year ‘presented a huge test for retirement investors’, amid volatile markets, with many savers facing tough choices about what to do with their retirement pots.
He adds: ‘With 2020 now thankfully behind us, pension withdrawal patterns appear to be returning to what we saw before the pandemic struck. This likely reflects increased consumer confidence as society gradually opens up, the success of the vaccine programme and a rally in investments since April last year.’
The chart below shows the number of individuals who have withdrawn their pension and the total value of payments since April 2015.
- Find out more: how coronavirus is impacting pensions and investments
Why are pensions being overtaxed?
Those wanting to access their pension pot can do so in two ways. The first is to take an uncrystallised fund pension lump sum (UFPLS). You can take a 25% lump sum of your pension tax-free, then the rest is charged at your normal income tax rate.
You can also take a lump sum from a pension drawdown plan. If you do this, 25% of your total pension savings are tax-free and any subsequent withdrawals are subject to income tax.
Your pension company collects the tax on your behalf, so the lump sum you get is paid net of tax. However, many people overpay tax the first time they withdraw from their pension. This is because your provider may not know what your tax code is or details of your other income if you have any.
If your provider doesn’t have this information, withdrawals are taxed using a higher-rate emergency tax code, calculated on what is known as a ‘Month 1’ basis.
This means you’ll be taxed as though the lump sum you’re withdrawing will be repeated every month. For instance, a £10,000 withdrawal could see you being taxed as though your annual income is £120,000. If this goes unnoticed, it can make an unnecessary dent in your overall pension pot.
- Find out more: income drawdown calculator
Could you be owed a pension tax refund?
In the first 3 months of 2021, HMRC paid back £23m in overpaid pension tax, down from £32m in the same period last year. In total, it’s paid back £716m since the freedoms were introduced.
However, these figures relate to the amounts repaid as a result of claims being submitted on either a P55, P53Z or P50Z form (more on these below) and do not include repayments through coding adjustments as a result of the end of year reconciliation.
The number of people making a claim has gone down over a year. There were over 7,000 official reclaim forms processed by HMRC in the first three months of 2021, compared with 10,000 in the same period last year.
Selby says: ‘In reality, £716m is just the tip of the overtaxation iceberg, as it only covers those who fill out HMRC’s official reclaim forms – something we know most people don’t do.
‘To give an idea of the scale, in 2020 around 38,000 official reclaim forms were processed by HMRC. In the same year, over 600,000 people flexibly accessed their retirement pot for the first time.
‘Given the steadfast reluctance of HMRC to even countenance reform of the taxation of pension freedoms withdrawals, it is down to individual savers to navigate the system to ensure they aren’t short-changed.’
How to claim back pension tax
If you’ve taken money out of your pension, it’s important to check that you haven’t paid more than you should and take action to reclaim your money.
The process is relatively straightforward and can be done online via the government’s tax refund website.
If you’ve overpaid tax, you’ll 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.
A P53Z form should be completed if you have withdrawn all of your pension and also receive other taxable income.
A P50Z form should be completed if you’ve withdrawn all of your pension, but have no other taxable income. If you don’t want to use the government’s online service, you can fill out a form on-screen, print and post it to HMRC, or print off and fill in a form by hand. HMRC says you should receive a refund of your overpaid tax within 30 days.
- Find out more: income drawdown calculator
Should I withdraw my pension?
Pension drawdown allows you to access your pension pot to provide you with a regular income.
The income you get varies on your fund’s investment performance and, unlike an annuity, it isn’t guaranteed for life.
However, it could be suitable if you want to have more control over how your money is invested. It may also benefit you if you want the flexibility of taking out different amounts during the year and want to manage your tax liability. However, there are other things you need to take into consideration before withdrawing your money.
Some of your pension is likely to be invested in stock markets in the UK or around the globe, which can be volatile, so you need to be prepared for a situation where the value of your pot may fall.
If you want a guaranteed income for life, are concerned about running out of money or don’t want to expose your pension pot to investment risk, income drawdown may not be for you.
If you do wish to withdraw, make sure you don’t make any rushed decisions that could affect the longevity of your savings. It’s important that you have enough to last the rest of your life.
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