HM Revenue and Customs (HMRC) has confirmed it has refunded over £26 million in the last three months alone to individuals aged 55 and over who paid too much income tax when drawing down money from their pension savings.
A quirk in the pension freedoms rules means that those even on modest incomes could potentially pay the 45% tax rate on the first lump sum drawn down from their pension savings pot. That’s due to emergency tax codes applied by the pension providers to all initial withdrawals, which – often inaccurately – assumes the lump sum withdrawn is one-twelfth of an individual’s annual income.
Individuals who draw down on their pension pot for the first time are experiencing emergency tax codes because pension providers are unaware of personal tax codes; nor are they aware of income from additional streams, making it difficult to deduct the correct amount of income tax from the draw down.
For example, an individual drawing down as little as £15,000 from their savings pot would be taxed by their pension provider the same way as an individual earning £180,000 per annum.
The more serious knock-on effect from being taxed in this way is that individuals could risk losing some, if not all of their tax-free annual allowance. Tax-free allowances fall by £1 for every £2 earnt over £100,000 per annum and disappear altogether for those thought to be earning £123,000-plus per year.
Official figures from HMRC demonstrate that 10,576 pension tax refund claims were made by individuals between 1st April – 30th June 2017, totalling £26.8 million refunded and amounting to £2,500 per person on average.
How to reclaim overpaid pension tax
Refunds to pension tax can be claimed through one of three forms:
P55 – used to reclaim overpayment of tax when you’ve flexibly accessed part of your pension pot
P53Z – used to claim back tax owed back to you on a small pension lump sum you had
P50Z – used to claim back pension tax when you’ve stopped working and flexibly accessed your pension pot
If you’re concerned about how much tax you’ve paid on drawing down from your pension pot, please don’t hesitate to contact us today for professional advice from your nearest TaxAssist Accountant.