Pension tax emergency
FIVE-MINUTE GUIDE TO...
NOBODY likes paying tax but it is even more galling if that money actually belongs to you and has done so all along.
This is exactly what is happening to thousands of people making withdrawals from their pension, as HM Revenue & Customs (HMRC) knowingly takes too much tax and leaves you to claim it back.
The amount of “emergency tax” reclaimed totalled £54 million in the three months to September 30, the highest quarterly figure since pension freedoms were introduced in 2015.
In total, people have reclaimed
£535 million but the amount overcharged will be far higher, as most wait to get their money back at the end of the tax year.
The average overpayment is now a substantial £3,000 per person, pushing some into financial difficulties.
TAX SHOCK
When you withdraw funds from your pension after age
55, you can take a quarter free of tax but the remainder is added to that year’s earnings and charged income tax.
If your pension company does not have your PAYE code, which it normally will not, HMRC requires it to operate an emergency rate.
This will treat a single lump sum withdrawal as if you are taking it every month, so you could easily find yourself paying income tax at 40 per cent on at least some of the money, when you should be paying 20 per cent.
Royal London director of policy Steve Webb said HMRC has snubbed calls for an overhaul from the Office of Tax Simplification: “It cannot be right that tens of thousands of people each year have too much tax taken out of their pension and then have the hassle of filling in a form to get back money that is rightfully theirs.”
TRUE TO FORM
Tom Selby, senior analyst at investment platform AJ Bell, warned this could force some into the arms of a high-cost lender. “This may cause distress and financial hardship,” he said.
Andrew Tully, technical director at Canada Life, said HMRC adjusts its systems quickly for those taking regular income but you must be careful when taking one-off withdrawals for a specific purpose, such as buying a car, paying off debt, helping children buy a house or long-term care. “If you take out £20,000, expecting to have £16,000 after basic rate tax, you may end up with just £12,000.”
You could withdraw more to plug the gap, if you have the money, but will be overcharged tax on that as well.
To reclaim the money, complete form P55 if taking part of your pension, P53Z if you are fully encashing and have other income, or P50Z if fully encashing with no other income.
“There is no need to wait until the end of a tax year and HMRC should make the refund within 30 days,” Tully added.
To avoid paying too much tax take a small initial payment of say, £100, which forces HMRC to issue your pension company with a tax code, at which point make a full withdrawal.
“The tax should be more accurate, although you may still have to make a small reclaim,” he said.