Savers are being forced to overpay tax to the tune of £20million every single month, with the total amount overpaid topping £1billion. The tax is charged on the over 55s who withdraw lump sums from the workplace or personal pensions, and the total sum is climbing all the time.
The average tax overpayment is now £3,252, money cash-strapped Britons desperately need to help them survive the cost-of-living crisis.
Over the three months to the end of September, pension savers handed over £61.3million to HMRC.
Incredibly that is almost double the £33.1million unnecessarily paid in the same quarter of last year.
The good news is that savers will eventually get their tax overpayments back, but the system is slow and complicated.
Since 2015, the over-55s have been free to withdraw money from their pensions whenever they wish, under pension freedom reforms.
Pension withdrawals are added to your total income from all sources for that financial year, and will become subject to income tax if you exceed your £12,570 personal allowance.
A quirk in the rules that has previously been called “scandalous” continues to force many savers to pay more income tax than is necessary.
When an over-55 makes a single lump sum pension withdrawal it is taxed under something called a ‘Month 1’ emergency tax code.
This assumes they are going to withdraw exactly the same amount every month for the year, even if they have no intention of doing so.
HMRC assumes they are going to take 12 times as much income as they plan to do. Then they are taxed according to this clearly inaccurate rule of thumb.
Many don’t realise they are going to be automatically overtaxed until faced with a shock tax bill which averages £3,252 but can be a lot more for those making larger withdrawals.
HMRC will eventually refund the overpaid tax but the system is slow and complicated. Taxpayers often have to wait until the end of the financial year, adding to cost-of-living pressures.
As well as facing an anxious wait to get their own money back, they also depend on HMRC getting its sums right.
Ian Cook, chartered financial planner at Quilter, said the amount of unnecessary tax charged on pension withdrawals continues to climb at speed, up 89 percent in the last year.
This shows that more of us are raiding our pension pots compared to a year ago. “Unfortunately, they are stuck with an archaic system that over-taxes them and leaves them waiting for a lengthy period before they can get the money owed to them.”
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Cook said the tax overpayment is particularly frustrating for those trying to access their funds quickly. Worse, often people do not understand why this has happened.
This has been an issue for years and the system needs an overhaul, he added. “The current process is leaving an increasing number of people facing emergency tax at a time they need their money most.”
It is possible to get your money back within 30 days, but only if you fill out one of three HMRC forms to reclaim your money.
The form depends on how you accessed your money. Use P50Z if the payment used up your pension pot and you did not work or receive benefits that tax year. Form P53Z is for those who used up their pension and are working or getting benefits. Those who flexibly accessed just part of their pot should complete form P55.
Otherwise claim the money back through your self-assessment tax return.
Andrew Tully, technical services director at Nucleus Financial, called on HMRC to take a fresh look at its policy.
He also suggested a work around for those making their first pension withdrawal. “Start by taking a small sum of, say, £100. That will generate a tax code from HMRC which the pension provider will apply to any subsequent withdrawals.”
A Government 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.”
Yet it still seems unfair that taxpayers should have to wait so long for money that has always belonged to them.
