AJ Bell expert Tom Selby has the answer to this question
Why am I being taxed so much on a pension withdrawal?
Steve from Stroud Last month I took a £20,000 uncrystallised funds pension lump sum (UFPLS) payment from my pension to pay for renovations to my house. I don’t have any other income so assumed I’d only pay tax of about £1,700.
However, I’ve just received my payment and it’s less than £13,000 – can this possibly be right?
Unfortunately it sounds like you’re one of tens of thousands of people to fall foul of the pension freedoms tax trap.
Under Government rules anyone who accesses their retirement pot for the first time using the pension freedoms is taxed on a ‘Month 1’ basis.
This is an emergency tax code and means you receive 1/12th of your usual tax allowances.
So while normally you’d expect any income below £11,850 to be tax-free, where Month 1 is applied this reduces to just £987.50.
Similarly, the size of your basic-rate tax band drops from £34,500 to £2,875, while the higher-rate band falls from £115,500 to £9,625. Any income beyond this will be taxed at the additional rate of 45% under Month 1.
All of that means your hardearned pension risks being hit with significantly higher tax charges than you would normally expect.
It’s worth noting this doesn’t affect everyone who accesses their pension flexibly. If someone takes a regular income or multiple payments from their fund in a tax year then HMRC should be able to reconcile their tax position without them doing anything.
In your case, however, the best way to be absolutely sure you get the pension you are owed is by filling out the relevant Government reclaim form. You can find these forms here: www.gov.uk/claim-tax-refund
If the withdrawal used up your entire pension pot and you have no other income in the tax year, you need to fill in form P50Z.
If the payment used up your fund and you have other taxable income, fill in form P53Z.
Finally, if the payment didn’t use up your pension pot and you’re not taking regular payments, fill in form P55.
The good news is once you have filled out the appropriate form HMRC should refund you within 30 days. However, if you do nothing then there is no guarantee when your money will be paid back to you.