Pension withdrawal: How can I avoid paying emergency tax to HMRC on this sum?
I have a drawdown pension worth £84,000.
I will be 74 in December 2023, and my spouse is 72.
This tax year I would like to take 25 per cent tax-free cash.
My total income arising from an occupational pension in payment and state pension is around £30,000 per annum.
So in addition to taking 25 per cent tax-free cash I intend to take an additional lump sum this tax year from the drawdown pension so that I only pay 20 per cent tax up to my annual allowance limit of £50,270.
In other words, this would be an additional £20,000 at 20 per cent tax.
However, my pension firm advises me that they will apply an emergency tax code on this £20,000 and then I need to reclaim overpaid tax from HMRC.
My question is could I request HMRC to advise me/my pension firm prior to taking the £20,000 that only 20 per cent tax should be applied, saving me further effort to communicate with HMRC to refund me overpaid tax for this tax year?
Is there any standard template I can use to contact HMRC about my intentions as above?
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Steve Webb replies: The issue that you raise relates to the way that HMRC chooses to collect tax when someone accesses their pension pot.
In your situation, where you have annual income of £30,000 and choose to take £20,000 of taxable cash from your pension, you would think that you should only pay basic rate tax on all of this because you are under the £50,270 threshold for paying higher rate income tax.
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And this is indeed where you will end up. But, unfortunately, you will have to jump through some hoops to get there.
The problem is that although you know that you only intend to make one withdrawal of £20,000 in the current tax year, HMRC do not.
From their point of view, you might be planning to make multiple withdrawals of this amount, and these would clearly take you into higher rate tax.
If they only deducted basic rate tax they would be concerned that they had under-taxed you and would then have to find a way to get the extra tax.
The way HMRC deal with this is to expect your pension provider to apply an ’emergency’ tax code.
This takes no account of your other income but instead assumes that you are going to make multiple withdrawals and (over) taxes you accordingly.
To get your money back you then have to fill in the relevant form or claim online: Claim back tax on a flexibly accessed pension overpayment (P55).
As you will see, if you choose to fill in a form you need to pick the right one. These are:
– Form P55 if you have flexibly accessed your pot but not run it down, and don’t plan to make any further such withdrawals;
– Form P53Z if you have flexibly accessed your pot and emptied it out;
– Form P50Z if you have flexibly accessed all of your pot and you have stopped work.
If you do not do any of these things, any refund owed will be delivered via the end-year tax assessment process.
As you rightly say, this is all a bit of a nonsense. I have repeatedly complained that HMRC routinely over-taxes people and then expects them to claim back their own money.
Since this system was first introduced in the wake of the ‘pension freedoms’ legislation, HMRC has had to refund a staggering £1.1billion in respect of around 400,000 pension withdrawals.
This system causes major disruption for people and is all about the convenience of HMRC rather than the taxpayer.
There is however a possible ‘work around’ which may largely deal with this problem.
Rather than make a single withdrawal of £20,000, you could consider making a (very) small initial withdrawal first. Although an emergency tax code will be applied to this small withdrawal this should then trigger the issuing by HMRC of a regular tax code to your pension provider.
They can then apply this to your main withdrawal and you should not be over-taxed on that.
In terms of the amount we are talking about, a lot depends on the rules of your drawdown arrangement. Some providers will have a minimum withdrawal amount (eg £1,000), some will charge for each withdrawal, and some will only allow a certain number of withdrawals per year.
But in principle, it should be possible to split your withdrawal into an initial nominal amount and then a subsequent main withdrawal. And, all being well, this should mean that you can largely avoid being over taxed.
Of course, it would be better if you didn’t have to go through this slightly artificial procedure all to avoid being overtaxed in the first place!
