Savers wrongly overtaxed £3,250 on pension withdrawals

Over-55s were wrongly taxed £143m last year for dipping into their pension savings for the first time, due to a long-standing issue with the tax system.

Savers were forced to claim back £3,248 each on average in 2021 after being overcharged by HM Revenue & Customs. This was after they triggered “emergency tax” rules by taking their pension.

The tax malfunction has caught out savers since the pension freedom rules were introduced in 2015, which allow people to divert their retirement savings into cash from the age of 55. More than £835m has been overcharged over the last seven years.

Drawing money out of a pension for the first time sets off HMRC's emergency “month one” tax on single withdrawals. By making a large withdrawal in one month, the taxman expects that to be the monthly income across the entire year and taxes them accordingly. So someone withdrawing £10,000 is taxed as if they earn £120,000 a year.

This means anyone planning to dip into their pension may get thousands of pounds less than expected. Savers received £42m in repayments in the last three months of 2021 alone.

Sir Steve Webb, a former pensions minister and now partner at consultancy LCP, said it was a “disgrace” that ordinary savers who wanted to access their pension savings were routinely overtaxed and forced to claim back the excess.

“This ‘money merry-go-round’ has gone on long enough. The system is run purely for the administrative convenience of HMRC rather than the benefit of taxpayers,” he said.

Tom Selby of AJ Bell, the stockbroker, said it was “beyond belief” that the issue had not been resolved despite recurring every year. He called for a “long overdue upgrade”.

If you have overpaid, you can wait until the taxman automatically reviews tax codes and assigns you to the right code but it could take more than 12 months to get your money back. You can ask for a refund sooner by filling in a "mini tax return" on one of three forms.

The “P55” form is for people making only a partial cash withdrawal from their pension. If you are taking an entire pension as cash you must either fill in “P53Z”, if you are still receiving other income, or the “P50Z” if you have stopped working.

The forms were created for pensioners wanting to claim their money back in the middle of the tax year, with HMRC promising to pay a refund out within 30 days of submitting the form.