Several UK pensioners have recently received tax rebates, averaging £2,800 each. This follows overpayments on pension withdrawals due to an outdated emergency tax system. Since the 2015 pension reforms, those tapping into their “defined contribution” schemes have faced emergency tax rates rather than their usual income tax rates.
The emergency tax system assumes that individuals will withdraw large amounts monthly, which often leads to higher taxation than necessary. For instance, if a pensioner withdraws £10,000 in one month, HMRC taxes them as if they are taking out £120,000 annually.
Between January and March this year, HMRC handled over 15,000 tax refund applications, resulting in £44 million being refunded, with an average refund of £2,881. According to AJ Bell’s research, this is the lowest average refund in the past six years.
To recover overpaid taxes, pensioners need to file a claim themselves or await HMRC’s evaluation of their self-assessment payments. Though the refund process corrects the overtaxation, it can be slow, taking several months.
Since the tax changes in 2015, over £1.4 billion has been reclaimed by those who overpaid taxes on pension withdrawals. Despite continuous appeals for reform, many see the system as outdated and ineffective. Experts, like Tom Selby from AJ Bell, argue that the emergency tax system adds unnecessary financial pressure.
“HMRC’s old method of taxing flexible pension withdrawals continues to burden savers,” stated Selby. He noted that even though £1.4 billion has been refunded, the tax system’s inefficiency is a considerable problem.
There is some optimism for pensioners receiving regular withdrawals. Starting in April 2025, the government will introduce a more efficient taxation process. This will enable a quicker transition from the emergency tax code to the correct rate for regular pension incomes.
Selby highlighted that the existing system is unsuitable for those making occasional pension withdrawals, leading many to face excess taxation because HMRC doesn’t adjust the tax rate correctly. Even after 10 years of pension freedoms, experts believe the government still hasn’t updated the system to align with these changes.
“It’s unacceptable that after a decade of pension freedoms, the system remains unchanged,” Selby added. He suggested that taking an initial small, nominal withdrawal could help HMRC apply the accurate tax code for future withdrawals.
Pensioners making occasional withdrawals can reclaim overpaid taxes by completing one of three forms from HMRC. If completed correctly, refunds are usually processed within 30 days. Otherwise, pensioners might receive their refunds at the year’s end after HMRC reviews their submissions.
Though the system is outdated, pensioners can still get their overpaid taxes back. However, ongoing calls for reforms indicate this inefficient process will continue to affect many.
As claims and refunds are processed, pressure is increasing on the government to modernize the tax system. Expected changes for pensioners with regular drawdowns are due in 2025, bringing hope for efficiency. However, those taking lump-sum withdrawals might still face overtaxation for some time.
For now, it’s crucial for pensioners to be mindful of potential overpayments on withdrawals and understand how to reclaim them. Being proactive and informed is critical to navigating this outdated tax system.