HMRC pays back £1bn in tax on pension withdrawals

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HMRC pays back £1bn in tax on pension withdrawals
Hollie Adams/Bloomberg

Savers have reclaimed more than £1bn in overtaxation on pension withdrawals since 2015, according to figures published by HM Revenue & Customs.

In an update today (April 26), HMRC revealed that from January to March 2023, 15,856 people successfully claimed back a total of £48.5mn in overpaid tax on flexible withdrawals.

This was the highest Q1 figure on record and second highest of any three-month period since April 2015. 

However, adding up all the quarterly figures since 2015 took the total overpaid tax – which has been refunded - on flexible pension withdrawals to around £1.018bn since pension freedoms were introduced.

Andrew Tully, technical director, Canada Life, said the latest HMRC numbers just show how complex the tax position around pension withdrawals is.

“Eight years on from the introduction of the pension freedoms there must be a better way to administer the tax position around flexible pension withdrawals which would mean HMRC is not processing refunds to the tune of £1bn,” he said.

“A good tip for those customers making a pension withdrawal for the first time, is to initiate a small withdrawal of say £100. 

“That will generate a tax code from HMRC which the pension provider will apply to any subsequent withdrawals. That will result in the tax being taken at source being far more accurate in many more cases, not only reducing the burden of paperwork but equally importantly the customer receiving a more accurate withdrawal in the first place.”

Source: AJ Bell analysis of HMRC statistics

Under current rules, when an individual first takes money out of their defined contribution pension they are often charged at an ‘emergency’ tax rate, with the duty then being on the saver to claim back overpaid tax by filling in one of three forms.  

In addition to money repaid by HMRC to those who fill in a claim form, there will be some savers who didn’t fill in a form and eventually get a tax refund when they fill in their tax return.  

Steve Webb, partner at LCP explained that HMRC does not publish figures for the numbers in this group but this does mean that the total amount of over taxation is likely to be significantly above the reported figure of £1bn.

“This is an absolute disgrace,” Webb said. “A system based on systematic over-taxing of pension savers cannot be right. 

“There is no good reason why citizens who access their pension should have to go through the hassle of claiming back excess taxation which they should never have had to pay in the first place. 

“And we are not talking about small sums, with over £1bn being paid back by HMRC so far. Reform of the system is long overdue so that it works to the benefit of pension savers and not the Treasury.”

In total, HMRC has re-paid the following:

Tax years

2015 - 2016£92,846,795
2016 - 2017£105,615,526
2017 - 2018£106,787,662
2018 - 2019£128,595,114
2019 - 2020£166,619,969
2020 - 2021£115,616,673
2021 - 2022£142,199,554
2022 - 2023£160,355,493

Source: Canada Life

The data revealed that the average reclaim in Q1 2023 was £3,062, down slightly versus the previous quarter – suggesting more people are accessing smaller retirement pots.

Tom Selby, head of retirement policy at AJ Bell, said it was astonishing that over £1bn has now been reclaimed by savers.

“It is a scandal that government has failed to adapt the tax system to cope with the fact Brits are able to access their pensions flexibly from age 55, instead persisting with an arcane approach which hits people with an unfair tax bill, often running into thousands of pounds, and requires them to fill in one of three forms if they want to get their money back within 30 days,” he said.

Selby explained that these recent figures also suggest the number of people accessing their pensions is on the rise as the cost-of-living crisis continues to eat into people’s living standards. 

“In fact, the £48mn repaid to people in January, February and March this year was the second highest figure on record, coming off the back of £45mn that was repaid in the previous quarter,” he said.

Source: AJ Bell analysis of HMRC statistics

“While it is good news that these people have at least received the tax they are owed, depressingly the true overtaxation number will likely be substantially higher. 

“In particular, people on lower incomes who are less familiar with the self-assessment process might be less likely to go through the official process of reclaiming the money they are owed. As a result, they will be reliant on HMRC putting their affairs in order.”

Selby said those who flexibly access their retirement pot as a result of spiralling inflation “at least have some breathing room” to rebuild their pensions after chancellor Jeremy Hunt hiked the money purchase annual allowance from £4,000 to £10,000. 

“This is still a substantial reduction on the standard £60,000 annual allowance available to those who haven’t accessed their pension flexibly, but it at least gives people a fighting chance of getting their retirement plans back on track when this crisis abates,” he said.

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.

Some individuals who use pension flexibilities can initially end up overpaying tax. This is because HMRC systems assume that a one-off payment will be a regular payment and, where the scheme doesn’t hold a P45 or similar for the individual, an emergency tax code is applied.

Affected individuals do not have to wait until the end of the tax year to be automatically refunded for any overpaid tax; instead, they can apply to HMRC for immediate tax reclaim (paid within 30 days).

A HMRC spokesperson said: “Nobody overpays tax as a result of taking advantage of pension flexibility. We will automatically repay anyone who pays too much because they’re on an emergency tax code. Individuals can claim back any overpayment earlier if they wish.”

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