Pension income is overtaxed and on the rise

Grant Blakey

Grant Blakey

Recent figures from HMRC on flexible pension payments make for interesting reading.

They generally indicate that the pension freedoms, introduced in April 2015, have been a hit for those taking payments, but that there are challenges which clients and advisers need to be mindful of.

As tax is deducted at source for pension withdrawals, scheme administrators must adhere to HM Revenue & Customs’ PAYE system.

This causes over-taxation due to the fact that, until the scheme administrator has a current tax code for the member, flexible pension income payments must be paid after the deduction of emergency tax.

This means if an income withdrawal is made in month one of the tax year, the scheme member will only receive one-twelfth of their personal allowance.

So individuals who are wanting to take a large one-off income payment and utilise their full tax allowances on their income early in the tax year – which just happens to be the most popular time of year to take annual payments – will be hit with a much higher tax bill than expected.

HMRC has created systems to allow the recovery of this excess tax, which is good.

However, since the pension freedoms were introduced, the total amount of excess tax HMRC has had to return now stands at over £433m, which is a huge amount of tax for individuals to have to wait to recover.

Clients can claim the tax back during the tax year by completing and submitting one of the following forms to HMRC: P55, P50Z or P53Z. The form required depends on the individual’s specific circumstances.

Failing that, HMRC will return the tax the following tax year.

In the short term, however, it means clients aiming to withdraw a specific net amount are having to withdraw larger gross amounts from a tax wrapper than they need to.

On the rise

Both of these issues are exacerbated by the fact that there is a clear upward trend in both the number of individuals who have flexibly accessed their pension benefits and the total value of withdrawals.

The number of individuals making withdrawals was fairly consistent in 2016-17 and 2017-18, but increased by more than 30 per cent in 2018-19.

There are now more than 1m people withdrawing flexible pension payments.

The total value in 2016-17 was over £6.4bn and this increased to almost 8.2bn in 2018-19, which is a 27 per cent increase.

If this trend continues on this exponential basis, more and more clients run the risk of falling into these traps, which will inevitably result in significantly more unnecessary tax being deducted.

Source: AJ Bell

The value of advice

The over-taxation issue arises as a result of the scheme administrator not having a current year tax code.