Pensioners clawed back an average £3,000 each – a record £54 million – from the taxman in the three months to September after they were overcharged on their withdrawals
In total, HMRC figures show £535 million has now been repaid to those who have filled out the official reclaim forms since April 2015, when pension freedoms were introduced and over-55s could draw on their money much more flexibly.
Pension freedoms gave savers the right to take any sum they wished from their retirement pot, but a quirk of HMRC’s system meant they were often overcharged tax on their withdrawals.
A one-off large withdrawal would be assumed to be a regular income payment and taxed at an incorrect higher rate. Savers then have to reclaim the overpayment. In the meantime, they risk being pushed into serious financial difficulty
Tom Selby, senior analyst at AJ Bell, says: “Given most people don’t fill out the reclaim forms, this is almost certainly the tip of a sizeable iceberg.
“It is time for the government to accept that, while the retirement flexibilities introduced in April 2015 have been well received by savers, the tax system that sits alongside them is simply not fit for purpose.”
Mr Selby wants a review of how retirement withdrawals taken using pension freedoms are taxed.
“People risk being left short of money as a result of HMRC’s approach and forced to either take out more cash from their pension, potentially paying extra tax in the process, or seeking the funds from elsewhere,” he says.
“The government’s failure so far represents a serious failure of policymaking which will inevitably have caused people distress and potentially significant financial hardship.”
Responding to the figures, an HMRC spokesperson says: “Nobody will overpay tax as a result of taking advantage of pension flexibility.
“Individuals can claim back any overpayment due to an emergency tax code being applied immediately and we will repay this in 30 days. Anyone who does not claim will be automatically repaid at the end of the year.”
Separate figures published by HMRC show the overwhelming appetite among savers to tax-manage their own pension withdrawals.
A total of £30 billion has been taken ‘flexibly’ from pensions using pension freedoms since they were introduced in 2015.
The average amount taken out each quarter per person has fallen, however, and now stands at £7,250.
This suggests people are phasing their withdrawals to minimise the amount of tax they have to pay.
Withdrawals peak after the start of the new tax year as individuals ‘smooth’ their withdrawals to avoid paying unnecessary tax by taking their money out in a larger lump in a single tax year.
Steve Webb, director of policy at Royal London, says: “There is evidence people are being savvy about the timing of their withdrawals, spreading them over more than one tax year to reduce their overall tax bill.
“But it remains the case that we need to increase the proportion of people who take financial advice or guidance before making decisions about how much of their pension to withdraw.”
Pension drawdown taxation
HMRC insist that providers apply a tax algorithm to drawdowns, which is fundamentally flawed. In essence, whatever the first withdrawal of the tax year amounts to, the formula multiples it by 12 to estimate your total withdrawals for the year. It does this even if the first withdrawal is made some time into the tax year. E.g. I made a first withdrawal in Month 4 and the formula was still applied.
You can apply immediately for a rebate, if you can find the form, which is rather buried in their website. Search for Form 50Z.
Finally, whilst HMRC prefers immediate payments to itself, via online transfer, it does not reciprocate. Response to a Form 50Z is quite quick, but repayment is much slower, and is eventually made by cheque, just to benefit their cashflow that little bit more!