HMRC has repaid £334 million in overpaid tax to over-55s since the introduction of the pension freedoms in April 2015.
Under the relaxed rules, pension savers are able to take cash out of their pension as soon as they turn 55. However, the way tax is applied to these withdrawals means it is highly likely they will be over-taxed.
Only the first 25% of so-called ‘uncrystallised fund pension lump sum’ withdrawals is paid tax free, the remainder is added to the individual’s income for the year and taxed at their marginal rate. Yet as the pension provider does not know how much income they have, HMRC requires them to charge emergency tax.
This £334 million figure only applies to people who have used HMRC forms to reclaim overpaid tax, so many more over-55s who have accessed their pension flexibly could be entitled to a refund.
Tom Selby, senior analyst at AJ Bell, says: “People who take a single pension freedoms withdrawal in a tax year continue to be punished by HMRC’s insistence on applying an emergency tax code to such payments.
“While the official figure of £334 million in tax repaid is astonishing itself, this only covers people who have filled out the official forms and is therefore likely to be the tip of the iceberg.
“Those who do not fill out a form have to rely on HMRC to sort out their affairs and could be left waiting until the end of the tax year to be put in the right position.
He adds: “Many people who make a single withdrawal will understandably be totally unaware their fund won’t be taxed in the same way as income in the first instance and so face a shock tax bill. In some cases, individuals will be forced to make another withdrawal from their fund to bridge the gap.
“It is clear that, at the very least, HMRC needs to formally consult on its approach to pension freedoms taxation to properly consider alternatives to the current regime.”
Withdrawals reach record levels
The latest pension freedom data from HMRC also shows that in the second quarter of this year, over-55s withdrew a record £2.27 billion from pensions, up by £1.7 billion in the previous quarter. Royal London notes that the number of people making withdrawals has risen - from 220,000 to 260,000 - as well as the average sum withdrawn, which has risen from £7,600 to £8,600.
Steve Webb, director of policy for Royal London, says it is too early to tell if this marks the start of a new trend. “These figures show the continuing popularity of pension freedoms. In the latest three months, over a quarter of a million people took the opportunity to make flexible withdrawals from their pension, and withdrawals were at a record level.
“The key challenge is to make sure that more people take advice and guidance when deciding how to access their pension savings so that they do so in a sustainable way that meets their objectives”.