Shock excess tax bills 'on the cards' over retirement withdrawals

clock • 2 min read
Shock excess tax bills 'on the cards' over retirement withdrawals

New figures from HMRC have revealed £794m has now been repaid to people overtaxed on retirement withdrawals since the pension freedoms were introduced in April 2015.

AJ Bell has highlighted the main problem behind the figures is that HMRC insists savers flexibly accessing taxable income from their retirement pot for the first time are taxed on a ‘Month 1' basis.

This means their usual tax allowances are divided by 12 and applied to the withdrawal - meaning people could be hit with shock tax bills running to thousands of pounds.

People could be hit with shock tax bills running to thousands of pounds."

Those who only make one withdrawal in the tax year need to fill out one of three HMRC forms in order to get their money back.

Tom Selby, head of retirement policy at AJ Bell said: "Savers accessing their pension need to be aware that HMRC will apply an emergency ‘Month 1' tax code to their first withdrawal, meaning they will initially be overtaxed - potentially by thousands of pounds.

"While those taking a regular income should have their tax code adjusted automatically, anyone making a single withdrawal in the tax year will need to fill out one of three HMRC forms to get their money back within 30 days.

"If they don't, they will need to wait to the end of the tax year, when HMRC says they should receive a rebate."

He added: "The Government is looking at increasing digitisation in the administration of pension tax relief as part of the Budget. Policymakers should use this opportunity to assess the current approach to the taxation of pension freedoms withdrawals.

"At the moment savers risk being left out of pocket to the tune of thousands of pounds when they access their retirement pot. If this process could be automated and the need to fill out a complex reclaim form removed, it would significantly improve the tax system for retirees."

If clients are taking a steady stream of income via drawdown then they shouldn't need to take any action, as HMRC will adjust their tax code to ensure that over the course of the year they are taxed the correct amount, A J Bell said.

However, if a single withdrawal is made then action is needed by filling out one of three forms or relying on HMRC to put in the correct position at the end of the tax year.

Which form is needed will depend on how the retirement pot is accessed: 

  • If the client has emptied the pot by flexibly accessing the pension and is still working or receiving benefits, they should fill out form P53Z
  • If the client emptied the pot by flexibly accessing the pension and is not working or receiving benefits, they should fill out form P50Z
  • If the client only flexibly accessed part of their pension pot then use form P55.

Provided the correct form is filled out, HMRC says there should be a full refund of any overpaid tax within 30 days.