Royal London has asked HM Revenue & Customs to change the way it taxes pension lump sum withdrawals, in its submission to the Work and Pensions Committee inquiry on pension freedoms.
Under current rules individuals seeking to withdraw a lump sum from their pension are usually taxed on an ‘emergency’ tax code which leads to an over-payment.
According to Royal London, in the first three months of this financial year HMRC paid out more than 10,000 refunds, worth more than £26m in total.
New quarterly figures are expected shortly and if refunds continue at this rate they are likely to imply a total over-taxation of more than £100m per year, the provider said.
Royal London said HMRC should only take the standard rate tax and collect any extra tax due through the usual end-year tax return process.
This would largely eliminate over-payments and avoid the need to process tens of thousands of refund claims, the mutual said.
Sir Steve Webb, director of policy at Royal London, said the way in which pension withdrawals are taxed is "little short of a scandal".
He said: “It cannot be right that HMRC can knowingly overtax people to the tune of £100m per year and expect thousands of individuals to know which form to fill in to get their money back.
“Too often, HMRC’s approach is to tax first and ask questions later, and this must stop.”
The inquiry, launched last month by the Work and Pensions Committee, is investigating whether the pension freedom reforms are working. The deadline for written submissions ends today (23 October).
The vast sums being withdrawn from retirement pots by the over-55s since the 2015 pension freedom reforms were introduced has pushed MPs to act.
HMRC figures showed £1.86bn was withdrawn in the second quarter of 2017, and in total £10.8bn has been withdrawn from pensions since the freedom changes were introduced in April 2015.
Royal London said the new rules gave choices to ordinary savers which were previously only the preserve of those on higher incomes.
But it identified several areas of improvement, besides the suggested tax changes.
The mutual called for earlier contact with pension savers, rather than a ‘wake-up’ pack six months before retirement when many will have already made up their mind.
Royal London also asks for enhanced access to advice, including more support for employers who offer workplace advice and a piloting of vouchers for financial advice.
Pension schemes and providers should also have more power to block pension transfers where they are concerned about the risk of ‘scams’, the company said.
Finally, the provider asked for a commitment by the government that it would be legislating to require all pension schemes and pension providers to supply data to the proposed pension dashboard.