Pension Freedom  

HMRC under fire for over-taxing pension withdrawals

HMRC under fire for over-taxing pension withdrawals

HM Revenue & Customs had to repay more than £25m in excess income tax taken from pension savers who withdrew funds using pension freedoms in three months.

A newsletter published by HMRC said that from 1 April to 30 June 2017 £26.8m was repaid.

HMRC revealed that in the three-month period it had processed more than 10,500 forms asking to a tax refund in respect of pension flexibility payments.

This means the average tax repayment to someone using the pension freedoms was £2,550.

Tom McPhail, head of policy at Hargreaves Lansdown, said the government has designed its tax system for pension withdrawals around what works best for its tax inspectors rather than putting the consumer first.

He said the result of this is a system which causes confusion for pension investors, cash-flow problems and the risk they end up paying too much tax. 

Mr McPhail said: “You wouldn’t let a private company get away with this so why is it OK for HMRC?”

Sir Steve Webb, former pensions minister and director of policy at Royal London, said: “It is outrageous that in just three months HMRC has over-taxed people by more than £26m. 

“It cannot be acceptable to take thousands of pounds per person in excess taxes and then expect people to have to claim that money back.   

“The rules need to be changed so that only basic rate tax is deducted and any extra tax due is collected through the normal tax return process.  This would be a far fairer system."

There have already been suggestions thousands of people who have been taxed too much on their pension withdrawals are failing to claim that tax back because many pension schemes do not have tax codes for their members.

To overcome this problem, HMRC requires the pension provider to apply tax on a "month one" basis which means it must assume that the sum withdrawn in the first month will be repeated every month.

If the member withdraws £10,000 in month one, the scheme will therefore assume that their annual income will be £120,000 a year, and tax them accordingly.

In the case of a £10,000 withdrawal, the member would pay £3,099.46 in tax but if the member made no further withdrawals that year, that £10,000 ought to be tax free.

Fiona Tait, technical director of Intelligent Pensions, said the figures demonstrate the unsuitability of using the emergency tax rules for payments made under pension freedoms. 

She said: “When pension funds are withdrawn as an income the emergency tax rules do not have much impact however the idea that the proceeds of an entire pension fund are treated as if they will be paid each month is ridiculous and it should not be beyond the wit of HMRC to devise a way for consumers to indicate up front whether a pension payment is an income or one-off lump sum. 

“HMRC’s own quarterly statistics, released this week, show that the number of withdrawals made under pension freedoms is increasing while the value of individual payments is decreasing. This means that increasing numbers of consumers are likely to face having to reclaim their income tax for cashing in relatively small pension amounts.”