The number of pension savers being hit with a tax bill on pension lump sum withdrawals has continued to grow.
Pension savers have been overtaxed by £400 million since pension freedoms were introduced in April 2015, new figures released by HM Revenue & Customs (HMRC) show.
The problem arises when individuals over the age of 55 make lump sum withdrawals from their pension. Under the pension freedoms the first 25% taken is tax-free, but the remaining 75% subject to income tax at an individual’s marginal rate.
However, a lack of information and to up-to-date tax codes leads HMRC to apply an 'emergency' tax code, which results in tens of thousands of pension savers being overtaxed each year.
While savers owed tax are repaid, as Moira O’Neill, head of personal finance at interactive investor (Moneywise's parent company), notes: “Repayments can take a long time and the process can be a huge inconvenience.”
HMRC has had to pay back tax on around 174,000 occasions since 2015, totalling £402 million in repayments. In the fourth quarter of 2018 alone, figures show over £30m was repaid to over 13,000 people.
The scale of these figures, says Helen Morrissey, pensions specialist at Royal London, underlines the need for HMRC to reform the way it handles tax free lump sums.
She says: "HMRC is utterly shameless in the way that it over-taxes people and then expects them to claim a refund.
“The system should be run for the convenience of taxpayers, not the convenience of HMRC. It is time that this over-taxing spree was brought to an end.”
Preempt emergency tax
Ms O’Neill offers the following advice for savers: “It’s worth planning well ahead when getting ready to start taking pension income - think about requesting only a nominal payment in order to trigger a new tax code."
Your tax code will then be set at the level of the initial payment. Ms O'Neill adds: "You can then withdraw the sum you originally intended to.”