HM Revenue & Customs (HMRC) has refused to change the way pension withdrawals are taxed, a system which has been branded "absurd" by a former pensions minister.
According to data from the taxman, 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.
In a report published in May, the Office for Tax Simplification urged HMRC to look at ways to fix this problem.
With the introduction of the new pension freedoms 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some cases, the pension provider will already have a proper tax code for the beneficiary, if the saver has previously withdrawn money from their pension during the tax year.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 later be reclaimed.
In a newsletter published on Friday (29 June), HMRC said that it has been reviewing the current process for flexible pension drawdown payments, but it has concluded "that any changes at the current time would not significantly improve the tax position for the majority of recipients of a flexible drawdown payment, when compared to the process currently in place".
The taxman argued the existing PAYE treatment of flexible pension drawdowns "remains the most effective method of deducting tax in these cases, and it reduces the risk of underpayments of tax arising".
A spokesman for HMRC said it will, however, continue to keep the current process under review and monitor drawdown and related claims.
Sir Steve Webb, director of policy at Royal London and former pensions minister, has been calling for a reform of the system.
He said: "Anyone who encounters the system for taxing one-off pension withdrawals knows it is a mess that puts the convenience of HMRC ahead of the needs of savers.
"Now we see that HMRC has reviewed the system, effectively 'marking its own homework', and has decided that everything is fine.
"This is simply not good enough and we now urgently need a proper independent review. It is almost impossible to explain to savers the amount that has been taken off in tax, and the deduction can even depend on what month it is. There must be a better way."
According to Ian Browne, pensions expert at Old Mutual Wealth, the taxman's statement will come as a blow to consumers, since it shows that HMRC continue to dig their heels in when it comes to treatment of pension drawdown.
He said: "In the first quarter of 2018, HMRC had to repay a staggering £22.5m in emergency tax. What the numbers haven't been revealed, and are more worrying, is how many people have been overcharged and did not claim it back."
Jessica List, pension technical manager at Curtis Banks, argued if PAYE is the best method to avoid underpaying tax, then it probably is the best of a bunch of imperfect solutions.
She said: "Although overpaying tax is very frustrating for consumers, in most cases it is probably preferable for someone to receive additional money at a later date than to get a request to pay some of it back.
"The problem is that any method could still result in some people over or under paying, so the most important thing is making sure that consumers are aware of this and making it as easy as possible for them to put it right."
For Tom Selby, senior analyst at AJ Bell, HMRC's belligerent refusal to countenance any public debate on this issue is deeply frustrating.
He said: "The current system was introduced without consultation and leaves millions of savers at risk of being hit with a shock tax bill.
"At the very least we need a public consultation on HMRC's approach to determine whether the current approach can be improved for the benefit of savers."
maria.espadinha@ft.com