Figures published by the tax authority last week (July 31) showed a mere 7,649 pension tax reclaim forms were processed between April and June, compared with more than 10,000 in the previous quarter and 17,000 in Q2 a year earlier.
Despite this, the average amount reclaimed per person hit a record high of £3,560 in Q2 - £845 more than during the same period last year.
The total amount reclaimed by people since 2015 has now reached £627m.
Source: AJ Bell
Tom Selby, senior analyst at AJ Bell, said: “While people taking a regular income should have their tax position sorted out automatically, those making a single withdrawal will either have to fill out one of three official forms or wait for HMRC to put them right at the end of the tax year.
“The overtaxation figures for April to June were always likely to be affected by Covid-19, with far fewer claims processed than usual.
“This may be because HMRC was stretched to breaking point as it responded to the challenge posed by the pandemic. However, it is clearly not ideal that thousands fewer people made a reclaim for the tax they were owed at a time when families were already facing up to huge financial pressures during lockdown.”
With the introduction of pension freedom rules, which came into force in 2015, savers have been able to take income from their defined contribution plans in any way they like.
But any withdrawals above the 25 per cent tax free amount are taxable at an individual's marginal rate of income tax.
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some cases, the pension provider will already have a proper tax code for the beneficiary, if the saver has previously withdrawn money from their pension during the tax year.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 has to be reclaimed later.
Many across the industry have called on the government to resolve this issue as “hard-working savers continue to be unfairly overtaxed for flexibly accessing their retirement pot”.
Mr Selby added: “The pension freedoms overtaxation problem appears to be getting worse rather than better.
“We are over five years into the pension freedoms and HMRC’s approach to the taxation of withdrawals – which was never formally consulted on – still hasn’t been officially reviewed. This affects hundreds of thousands of people, with the obvious risk that those who fail to make a reclaim are left short of cash when they need it most.
“Given the Treasury is already reviewing pension tax administration in relation to net pay pension schemes, it would make sense to review HMRC’s approach to the taxation of pension freedoms withdrawals alongside this.”
Those that have been overtaxed can fill in one of three different forms - the P55, P53Z and P50Z - which allow people to claim back money from HMRC mid-way through the tax-year.
Last week, HMRC revealed £2.3bn was withdrawn from pensions flexibly in the second quarter of 2020, and in the peak of lockdown, down from £2.8bn in the same period last year.
The average amount withdrawn was £6,700 in the quarter, an 18 per cent decrease from £8,200 in Q2 2019.
amy.austin@ft.com
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