Latest figures by HM Revenue & Customs revealed it had to pay back more than £900mn in overpaid income tax to people who have made flexible withdrawals from their pensions.
Since the introduction of pensions freedoms in 2015, savers have now reclaimed £925mn in overtaxation on pensions withdrawals.
Under current HMRC practice, when an individual first takes a lump sum from a defined contribution pension, tax is deducted at source.
However, instead of being deducted at the individual’s normal income tax rate, an emergency tax rate is used.
This is in case the individual were to make multiple withdrawals over the year which collectively took them into higher tax bands.
Individuals then have to fill in one of three different forms to claim back the overpaid tax.
Steve Webb, partner at LCP said: “It remains a quiet scandal that tens of thousands of people every year have to fill in forms to get back tax from HMRC which they should never have had to pay in the first place.
“It may be convenient for HMRC to overtax people and then force them to fill in forms to get their money back, but it is hardly putting the customer first.”
New figures revealed that more than £33mn was repaid to almost 10,000 people overtaxed on pension withdrawals in July, August and September, with an average reclaim of £3,324.
Adding together all of the quarterly figures since 2015 shows that the total refunded now stands at £925mn.
This is in respect of 270,000 forms, though it is possible that some individuals may have filled in more than one form.
Webb said a much simpler system would be for tax to be deducted at the basic rate with adjustments for those who may pay tax at a different rate, including through the annual tax return process.
“It is time for this scandal to end,” he said.
He argued that the £925mn is likely to be an understatement of the full scale of the problem.
LCP said no figures are available for the amounts refunded through this route, but it is likely that the total amount of overpayment will be over £1bn since the system began.
A HMRC spokesperson said: “Anyone who ends up paying more tax than they should due to an emergency tax code being applied will automatically be repaid at the end of the year.
“Individuals have the option of claiming back any overpayment earlier if they wish. Ultimately, nobody will overpay tax as a result of taking advantage of pension flexibility.”
FTAdviser understands that where an individual does not apply directly to HMRC for a refund, HMRC will work out their annual tax bill at the end of the tax-year as part of the usual reconciliation exercise.
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AJ Bell’s head of retirement policy Tom Selby, said: “While those who take a regular income or make multiple withdrawals during the tax year should be put right automatically by HMRC, anyone who makes a single withdrawal will likely be left out of pocket.