Thousands of individuals over the age of 55 have received a substantial refund from HM Revenue & Customs (HMRC), totaling a whopping £38 million. This refund addresses the issue of overpaid tax on pension withdrawals, sparking widespread calls for a much-needed reform of the current tax rules, which many deem unacceptable.
The final quarter of the previous year saw an astonishing £38.8 million being returned to approximately 13,000 claimants. These individuals, all over 55, had initially overpaid tax upon accessing their pensions for the first time. This significant refund indicates a systemic issue in the way pensions are taxed, particularly for those making their first withdrawal.
Understanding Pension Tax Rules
To grasp the root of the problem, it’s essential to understand how pension savings are taxed. Typically, when an individual starts withdrawing from their pension savings, they are allowed to take a quarter of the money tax-free. Any additional withdrawals are treated as income and, thus, are subject to income tax.
Since 2015, the tax authorities have been applying an “emergency” tax code to the first flexible withdrawal from a pension. This approach fails to consider any tax the individual has already paid during the year. As a result, many have faced unexpectedly high tax bills, unaware of this peculiar tax treatment.
AJ Bell, an investment broker, has estimated that since the introduction of this system in 2015, around £1.2 billion has been repaid to savers who were initially overtaxed on their first withdrawal. The average amount refunded in the last quarter of the previous year was about £3,200. This statistic underscores the widespread impact of this issue on ordinary citizens.
Tom Selby, director of public policy at AJ Bell, has criticised the government’s inaction, labeling the existing tax system as “unacceptable.” He argues that the government has failed to update the tax system to align with the reality that Brits can access their pensions flexibly from the age of 55. This outdated approach often results in unfair tax bills, sometimes amounting to thousands of pounds.
The Scale of Pension Withdrawals
Since the introduction of so-called pension freedoms in 2015, the total amount of taxable payments withdrawn flexibly from pensions has surpassed £72.2 billion. This figure, reported by HMRC last September, highlights the significant scale of pension withdrawals in recent years.
How to Claim a Refund
For those who have overpaid tax, there is a process to claim a refund. The specific form required depends on how the pension was accessed. Once the correct form is submitted, HMRC assures that savers should receive their refund within 30 days, provided there are no errors in the submission.
In response to the issue, HMRC has stated, “Nobody overpays tax as a result of taking advantage of pension flexibility.” They claim to automatically refund anyone who pays too much due to being on an emergency tax code. Additionally, individuals can claim back any overpayment earlier if they wish.