Treasury Banked £1.6bn in Tax From Pensions. Could You Be Paying Too Much Tax on Your Pension Withdrawals?

hmrc.jpgA quirk in the income tax system means HMRC is wrongly overcharging people who make use of new rules to draw cash from pensions.

Recent figures show the Treasury banked £1.6bn in tax from the first year of the pension freedoms (April 2015-16), nearly double its initial estimate of £910m. The discrepancy could be explained by a low ratio of people reclaiming overpaid tax, compared to those who have made withdrawals, experts suggest.Under the rules introduced in April 2015, over-55s can take regular or ad hoc sums from their pension pots.

 

But if someone makes a large withdrawal in a single month, the tax man assumes this will be their income each month and taxes you on an “emergency rate”.

The flaw means many are hugely over-taxed.

The overpayments can be reclaimed, but you need to fill out a onerous “mini tax return”, and there are concerns people cashing in small amounts may not even be aware they’ve lost out.

Robert Mohamed – a former investment banker – was shocked to be told he would be taxed £43,385 on a £100,000 withdrawal he planned to make from his pension pot. This was around £15,000 more than he should have paid.

The overpayment was caused by the “emergency tax” provision that treats a single withdrawal as the first of equal, monthly payments over the year. On the basis of his withdrawal HMRC assumed Mr Mohamed’s annual income would be £1.2m and taxed him accordingly. In most cases pension companies do not have the saver’s correct tax code and simply follow HMRC guidelines.

This means you only benefit from one twelfth of your £11,500 “personal allowance” – the income you can earn tax-free each year.

After turning 55 last year – the age at which pension cash can be accessed under the new liberalised rules – Mr Mohamed began drawing on his pension, which has a total value of around £1.5m and is held in a self-invested personal pension (Sipp).

He planned to draw down around £100,000 annually but wishes to do this in a single transaction each year rather than in monthly withdrawals.

How do you get your money back?

Pensioners who have overpaid must either wait for HMRC to put them on the correct tax code (a spokesman could not say how long this would take) or fill out one of three repayment claim forms.

In Mr Mohamed’s case this is the “P55 form” because he is only taking a partial cash withdrawal. If taking an entire pension as cash, you must either fill in “P50Z” (if you’ve stopped working) or “P53Z” (if you’re still receiving earned or other income). You can fill out the relevant form online so long as you have a “Government Gateway” account, or by post.

If your pension provider has an up-to-date tax code from HMRC, or a P45 from the current tax year, from the employer you retired from, you don’t have to do anything.

Mr Mohamed said: “Completing a P55 form for each withdrawal is frustrating. It’s archaic. In effect it’s a mini-tax return and many people will never have filled one out. “The system is unfair on people who save diligently for their pension.”

When do you get your money back?

The tax office promises to refund any overpaid tax within 30 days if the correct claim is submitted. A spokesman added that in cases where taxpayers submit the wrong form or don’t realise they need to make a claim, they will eventually be refunded.

However, he could not say how long this would take.

How much pension tax could you have overpaid?

The table below shows how much tax you should pay and how much could be taken if an emergency code is used instead . For simplicity, the entitlement to 25pc tax-free cash has been ignored.

The figures assume no other income is received. A single £10,000 withdrawal should be tax-free, because of the £11,500 personal allowance, but could be charged £3,057. Likewise, a £40,000 lump sum should attract a £5,698 tax bill but might face a charge nearly three times as high, at £16,385.

Withdrawal amount

Tax due if a single withdrawal

Potential tax taken under “emergency tax”

£2,000

£0

£208.00

£5,000

£0

£1,057.66

£10,000

£0

£3,057.66

£15,000

£698.00

£5,134.66

£40,000

£5,698.00

£16,384.66

HMRC’s insistence that an emergency tax code must be applied to pension freedom withdrawals means tens of thousands of people will have paid too much tax on their withdrawals – yet very few of them have reclaimed this tax.

This might be because they don’t know they have paid too much tax, or because the process to reclaim it just seemed too complicated.

Baroness Ros Altmann, the former pensions minister, said it was unlikely HMRC would change its stance as it would amount to “turkeys voting for Christmas”. She said: “It is incredibly complicated and HMRC is making it as difficult as possible.

She added that the tax office benefits from savers leaving other refunds unclaimed. “Many higher-rate taxpayers don’t realise they can claim extra tax relief on their pension contributions and millions goes unclaimed each year,” she said.

Could you have inadvertently paid too much tax on your pension? Or just looking to review your retirement provisions? Speak to Intelligent Investments today.

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