Some pension savers have been left with ’emergency’ income tax charges of over £50,000 after taking cash out of their pensions, new findings have revealed.
Since the dawn of pension freedoms in 2015, if someone makes an initial withdrawal from a defined contribution pension pot, HM Revenue & Customs assumes it will be the first of many over the rest of that tax year, which could push the individual into a higher tax band than normal.
It therefore applies an emergency tax rate on the basis that this could be only the first in a run of withdrawals. Since 2015, over £1billion has been overcharged.
Anyone who thinks they may be affected by the emergency tax saga can either wait until HMRC automatically reviews its tax codes and issues a refund, or request a refund by filling out a form, either on paper or online.
A taxing nightmare: Some pensioners have been left with ’emergency’ income tax charges of over £50,000
A spokesperson for HMRC, said: ‘Nobody overpays tax as a result of taking advantage of pension flexibility.
‘We will automatically repay anyone who pays too much because they’re on an emergency tax code. Individuals can claim back any overpayment earlier if they wish.’
After submitting a Freedom of Information Request, Royal London discovered that roughly 2,300 pensioners claimed back over £10,000 in emergency tax on their pension income.
In the 2022-23 tax year, 9,700 pensioners claimed back £5,000 or more. Of this figure, 300 received a cheque for more than £15,000.
According to Royal London, the average refund per saver came in at £3,062, but the top 100 claimed sums back averaging £54,185.
Sweeping changes to pension rules in 2015 means people can withdraw some or all of their defined contribution pension savings as lump sums from the age of 55.
But HMRC taxes the initial withdrawn sum as if that will be the pension saver’s monthly income every month for the duration of the tax year.
For instance, according to Royal London, someone taking out £30,000 would normally receive £7,500, or 25 per cent, tax free and the remaining amount is taxed as if their monthly income is £22,500, even if the pension holder has no intention of taking further pension income that year.
In other words, they would pay £8,503 in emergency tax. However, if the basic rate of tax was applied, the sum would be £1,984. The difference, or an extra £6,519, would need to be claimed back from HMRC.
Clare Moffat, a pension expert at Royal London, said: ‘Naturally, this could come as a huge shock to some people, especially if they had earmarked the money for something specific like a holiday or home improvements.
‘Suddenly, a big chunk of the money they thought they had coming to them has in fact gone to pay emergency taxes, which they probably hadn’t anticipated.’
She added: ‘The pension savers charged over £50,000 in emergency tax will of course be extreme cases. To trigger a tax bill of this size, they will have taken out a lump sum in excess of £200,000.
‘There aren’t too many scenarios in which someone will need this amount, except maybe to help their children or grandchildren get a foot on the housing ladder.’
One way to ensure you are not lumped with a hefty emergency tax charge is by making a smaller initial withdrawal from the defined contribution pension in question.
Moffat said: ‘A far better approach is to make your initial withdrawal a modest one and this will govern how much tax you pay on future withdrawals.
‘If you do need to make a large withdrawal, remember that you will pay more tax, especially if you have a large purchase in mind or something you need the money for.’
