Loophole allows savers to avoid pension emergency tax bill

Loophole allows savers to avoid pension emergency tax bill

Old Mutual Wealth has uncovered a way for savers to avoid being charged emergency tax on their pension withdrawals.

Ian Browne, pensions expert at Old Mutual Wealth, said if a provider creates three small pension pots of £10,000, these can be withdrawn at a basic tax rate, which means the individual won't be emergency taxed.

However, this will only work if the pension provider has an internal system to create these pension pots, and can only be done once in a lifetime, for the maximum of three pots.

According to data from HM Revenue & Customs (HMRC), since the start of pension freedoms, £305m had to be repaid to retirees where too much tax had been collected from those making flexible withdrawals from their pension savings.

With the introduction of the new rules in 2015, savers have been able to take advantage of the high transfer values of defined benefit schemes and to move their nest eggs into defined contribution plans, which they can then draw an income from at whatever rate they choose.

These withdrawals are taxable at an individual's marginal income tax rate.

In some cases, the pension provider will already have a proper tax code for the beneficiary, if the saver has previously withdrawn money from their pension during the tax year.

However, where the provider does not have the correct tax code for the individual – which is in the majority of cases -  withdrawals are taxed using a higher rate emergency tax code, which routinely results in an excessive tax deduction that then has to be later reclaimed.

According to Mr Browne, this is due to the fact that the PAYE system "is based on the assumption that regular payments are going to be made to the individual," and isn't designed for one-off withdrawals.

He said: "If you have an emergency and you have to make a withdrawal very quickly, reclaiming that tax takes weeks or even months, which actually means that you need to withdraw more than you need to get that payment out very quickly."

And the reclaimed money from HMRC cannot be put back into the pension, he added.

However, Mr Browne explained that if a pension provider creates three pension pots of £10,000 each from the saver's bigger pot, when these are paid out they will be taxed under the basic rate tax code instead.

He said: "These are three new pension pots that the provider creates, so it is an internal process that the provider has to have.

"That is why when financial advisers are revising pension propositions need to understand whether that provider can do this or not, so it is part of their due diligence."

Mr Browne argued financial advisers aren't as aware of this solution as they should be.

He said: "We, as a pension provider that does this, make sure that the advisers we work with are aware, but we do find that we have to repeat the message, because they are faced with a lot of information from lot of different providers."