Some pension savers have been left with ’emergency’ income tax charges of over £50,000 after taking cash out of their pensions, new findings have revealed. 

Since the dawn of pension freedoms in 2015, if someone makes an initial withdrawal from a defined contribution pension pot, HM Revenue & Customs assumes it will be the first of many over the rest of that tax year, which could push the individual into a higher tax band than normal.

It therefore applies an emergency tax rate on the basis that this could be only the first in a run of withdrawals. Since 2015, over £1billion has been overcharged.

Anyone who thinks they may be affected by the emergency tax saga can either wait until HMRC automatically reviews its tax codes and issues a refund, or request a refund by filling out a form, either on paper or online.

A taxing nightmare: Some pensioners have been left with 'emergency' income tax charges of over £50,000

A taxing nightmare: Some pensioners have been left with ’emergency’ income tax charges of over £50,000

A spokesperson for HMRC, 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.’

After submitting a Freedom of Information Request, Royal London discovered that roughly 2,300 pensioners claimed back over £10,000 in emergency tax on their pension income. 

In the 2022-23 tax year, 9,700 pensioners claimed back £5,000 or more. Of this figure, 300 received a cheque for more than £15,000.  

According to Royal London, the average refund per saver came in at £3,062, but the top 100 claimed sums back averaging £54,185. 

How to claim back the tax on a flexibly accessed pension

HMRC will automatically refund any overpaid tax at the end of the tax year. You could be waiting for a fairly lengthy period of time.

However, if you want to get your money refunded from HMRC sooner, it is possible. 

If you go down the DIY route, you will need to fill in one of three forms, depending on your circumstances. 

Here’s an overview of the forms: 

– Form P55 if you have flexibly accessed your pot but not run it down, and don’t plan to make any further such withdrawals;

Form P53Z if you have flexibly accessed your pot and emptied it out;

Form P50Z if you have flexibly accessed all of your pot and you have stopped work.

It’s possible to complete the form you need online, or send it in by post.  

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Sweeping changes to pension rules in 2015 means people can withdraw some or all of their defined contribution pension savings as lump sums from the age of 55. 

But HMRC taxes the initial withdrawn sum as if that will be the pension saver’s monthly income every month for the duration of the tax year. 

For instance, according to Royal London, someone taking out £30,000 would normally receive £7,500, or 25 per cent, tax free and the remaining amount is taxed as if their monthly income is £22,500, even if the pension holder has no intention of taking further pension income that year. 

In other words, they would pay £8,503 in emergency tax. However, if the basic rate of tax was applied, the sum would be £1,984. The difference, or an extra £6,519, would need to be claimed back from HMRC.

Clare Moffat, a pension expert at Royal London, said: ‘Naturally, this could come as a huge shock to some people, especially if they had earmarked the money for something specific like a holiday or home improvements. 

‘Suddenly, a big chunk of the money they thought they had coming to them has in fact gone to pay emergency taxes, which they probably hadn’t anticipated.’

She added: ‘The pension savers charged over £50,000 in emergency tax will of course be extreme cases. To trigger a tax bill of this size, they will have taken out a lump sum in excess of £200,000. 

‘There aren’t too many scenarios in which someone will need this amount, except maybe to help their children or grandchildren get a foot on the housing ladder.’

One way to ensure you are not lumped with a hefty emergency tax charge is by making a smaller initial withdrawal from the defined contribution pension in question.

Moffat said: ‘A far better approach is to make your initial withdrawal a modest one and this will govern how much tax you pay on future withdrawals. 

‘If you do need to make a large withdrawal, remember that you will pay more tax, especially if you have a large purchase in mind or something you need the money for.’

What’s the difference between defined contribution and defined benefit pensions?

 Defined contribution pensions take contributions from both employer and employee and invest them to provide a pot of money at retirement.

Unless you work in the public sector, they have now mostly replaced more generous gold-plated defined benefit – or final salary – pensions, which provide a guaranteed income after retirement until you die. 

Defined contribution pensions are stingier and savers bear the investment risk, rather than employers. 

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