A significant number of pensioners in the UK have encountered issues related to overpaying tax on pension withdrawals in recent years, with HMRC being at the center of efforts to address these overcharges. These overcharges often arise when one-off withdrawals from pension pots are taxed under an emergency tax code, leading to higher-than-expected tax rates.
According to new data, the scale of this problem is more extensive than previously thought, and it highlights the challenges many pensioners face when accessing their savings. Information provided by Manchester Evening News indicates a sharp rise in claims for tax refunds, while HMRC continues to refine its processes to address these concerns more efficiently.
Pension Withdrawals and Emergency Tax Codes: What Went Wrong?
Pension freedoms, introduced in 2015, offered greater flexibility for pensioners over the age of 55 to access their defined contribution (DC) pension pots. This policy change allowed individuals to withdraw up to 25% of their pension as a tax-free lump sum, while the remaining 75% is taxed as income. However, a major flaw in this system has come to light: the application of an “emergency” tax rate to one-off withdrawals.
When a pensioner makes a large lump sum withdrawal, HMRC applies an emergency tax code, assuming it will be the pensioner’s monthly income for the rest of the tax year. This results in overtaxation, with many individuals being taxed at a much higher rate than necessary. As a consequence, pensioners have been left facing unexpected tax bills, with some even overpaying thousands of pounds.
The Surge in Refund Claims: An Alarming Trend
Recent analysis has shown a significant rise in refund claims made by pensioners who have overpaid taxes on their withdrawals. In the 2023-24 tax year, approximately 60,000 pension savers sought refunds for overpayment. This represents a 20% increase from the previous year, when around 50,000 claims were made.
Notably, many of these pensioners received substantial refunds, with some reclaiming over £10,000, and a small number exceeding £100,000.
Clare Moffat, pension expert at Royal London, highlighted the issue, stating:
It’s incredible to think that some people withdrawing from their pension for the first time were entitled to emergency tax refunds in excess of £100,000. Not only do these taxes usually come as a massive shock, the unexpected tax amount can also scupper people’s carefully laid plans.
In total, HMRC has refunded approximately £1.4 billion since the introduction of pension freedoms in 2015. While HMRC maintains that they will repay anyone who overpays due to the emergency tax code, the system’s complexity remains a source of frustration for pensioners.
In fact, 11,700 pensioners claimed back £5,000 or more, with 2,400 receiving refunds of over £10,000. The average refund amounted to £3,342, a 9% increase compared to the previous year. The top 25 refunds averaged £106,900.
Clare Moffat also explained the potential future problems:
A rise in large lump-sum withdrawals will likely mean an even greater spike in emergency taxes on those withdrawals. So, the problem of emergency taxes isn’t going away, and there’s a chance it could get worse.
What Are the Solutions and How Can Pensioners Protect Themselves?
To address these concerns, HMRC has recently introduced changes to their processes to improve the speed and accuracy of refunds. Starting in April, tax codes will be automatically updated for individuals receiving private pensions for the first time, which should help prevent emergency tax codes from being applied in the first place.
However, as Clare Moffat points out, pensioners should still be aware of the potential for overtaxation, especially if they are making larger lump sum withdrawals.
The Government’s decision to impose inheritance tax on unused pension funds starting in 2027 is likely to lead to more people accessing their pensions to make large gifts to loved ones. This will likely result in more lump-sum withdrawals, which could, in turn, lead to even greater issues with emergency tax rates. Pensioners are encouraged to carefully review their tax codes and ensure that they are being taxed correctly when making withdrawals.
A spokesman for HMRC said:
Ultimately, nobody overpays tax as a result of taking advantage of pension flexibility. We will repay anyone who pays too much because they’re on an emergency tax code and individuals can claim a repayment much earlier if they wish.
