HMRC overtaxing pensioners forced to dip into their retirement savings to cope with cost of living crisis
Pensioners are overpaying record amounts of tax when they dip into their retirement savings.
This ‘quiet scandal’ is only expected to get worse as more older savers take cash out of their pension pots to cope with the rising cost of living.
And experts are now calling on HM Revenue & Customs (HMRC) to urgently rethink the way it taxes withdrawals.
Overcharged: Experts are calling on HMRC to urgently rethink the way it taxes withdrawals after it emerged a record amount of pensioners are overpaying
The 2015 pension freedom rules mean savers no longer have to purchase an annuity (an income for life) and can dip into their retirement fund.
Over-55s can take a quarter of the money as a tax-free lump sum. Anything over this is taxed at their usual rate.
But HMRC treats lump sum payments as if they are a permanent increase in income and applies an emergency tax code.
As a result, savers have been overtaxed to the tune of £892 million since 2015, AJ Bell analysis of HMRC data reveals.
You can get a tax refund within 30 days if you fill out a form. Otherwise, you have to wait until the end of the tax year.
More than £33 million was repaid to over 10,000 people who were overtaxed on pension withdrawals between April and June this year, according to HMRC’s figures.
The average refund was £3,363.
Steve Webb, former pensions minister and partner at consultants LCP, says: ‘It is outrageous that HMRC overtaxes thousands of people every month and expects them to fill in a form to get their own money back. HMRC needs to urgently rethink its approach.’
The issue is that tax is collected through the Pay As You Earn (PAYE) system, which is designed to tax your monthly income, rather than one-off payments.
It means HMRC assumes you will receive the same amount every month.
For example, if you have a regular income of £15,000 and take a fully taxable £10,000 lump sum from your pension pot, you should be taxed on £25,000.
Usually you would pay no tax on the first £12,570 of your income, known as the personal allowance, and then 20 per cent basic rate of tax on the next £12,430.
This works out at £2,486. So you have paid £2,000 of tax on the lump sum and £486 on your usual £15,000 income.
Instead, under HMRC’s system over-55s end up paying a higher rate of tax on more than half of their withdrawal.
With a £10,000 lump sum, you would pay no tax on the first £1,047 — the equivalent of one month’s personal allowance (£12,570 divided by 12).
You’d then pay 20 per cent basic-rate tax on the next £3,141 (the basic-rate allowance of £37,700 divided by 12), which works out at £628.
Then you would pay 40 per cent on the remaining £5,812, which is £2,324.
Your total tax bill for the pension lump sum is £2,952 — an extra £952.
Use form P55 to reclaim emergency tax if you have taken part of your pension pot and are not withdrawing a regular income.