The total income tax which has been overpaid, then refunded, on flexible lump sum pension withdrawals since 2015 now exceeds £1bn.
And it is worth a reminder this is only the refunds driven by the completion of forms P50Z, P53Z and P55.
A great many other people either won’t know these forms exist or won’t complete them, meaning HM Revenue & Customs will sort out any tax overpayment directly with the individual.
These are substantial numbers and this is a significant issue. Eight years on from the introduction of the pension freedoms, we really need to find a better way of dealing with tax on lump sum withdrawals which doesn’t continually overtax savers.
Over £48m was repaid in Q1 2023, up massively from the £22m in the same quarter of 2022
Some may argue this isn’t a big issue, as people are refunded the tax, hopefully by the end of the tax year and potentially sooner if they complete the relevant form. However, this fails to consider the impact overpaying tax can have on people, many of whom may not be working or have limited other income.
Take the following example. Here the individual takes £13,333 from their pension. After taking 25% tax-free cash, there is a taxable amount of £10,000. The tax due under emergency tax on that withdrawal is close to £3,000.
| Band | Amount | Tax rate | Tax due | |
| Tax-free | 1/12 of the personal allowance | £1,048 | Nil | £0 |
| Basic rate | 1/12 of the basic rate band | £3,142 | 20% | £628 |
| Higher rate | 1/12 of higher rate band | £5,810 | 40% | £2,324 |
| Total Tax | £2,952 |
Given many people taking money out are basic rate taxpayers or non-taxpayers, they will be significantly overpaying tax.
Most people withdrawing funds from their pension are likely to be doing it for a specific reason – to help with a particular expense.
While they may have made some plans, they are unlikely to be withdrawing funds many months before the expense arises. When the amount received is significantly lower than expected and needed, some may be forced to ‘double dip’ by taking a further pension withdrawal.
There are around 15,000 forms completed each quarter in addition to the many who don’t complete forms but need HMRC to adjust tax
That double dipping means many may be withdrawing more from their pension than they need, to cope with a cash flow problem. This doesn’t help with their overall retirement planning.
There is also a huge cottage industry within HMRC processing these refunds. If we dig into the most recent figures a little more, it shows over £48m was repaid in Q1 2023, which is up massively from the £22m in the same quarter of 2022.
And it is the second highest quarterly withdrawals we have seen, with the £45m repaid in Q4 2022 not far behind. That means there are around 15,000 forms completed each quarter in addition to the many individuals who don’t complete forms but need HMRC to adjust their tax.
If we could find a better way of collecting tax on lump sum withdrawals, it must be more efficient for HMRC, as well as a much better experience for pension savers.
The Office for Tax Simplification, before it was scrapped, identified lump sum pension withdrawals as an area greatly in need of simplification, saying it wanted to work with HMRC to identify options other than using emergency tax codes. However, the government never took this recommendation any further.
Asking lower paid workers to pay thousands more in tax than they should isn’t good enough
It is understandable why HMRC prefers this system. Gathering more tax upfront and returning overpayments at some future point is a sure-fire way of making sure enough tax is collected. But the system appears to be weighted too far towards HMRC and not towards trying to make sure a much more accurate amount is deducted in the first place.
Most people will accept these things can’t be exact to the penny but asking lower paid workers to pay thousands more in tax than they should – with the excuse they will get a refund at some point – frankly isn’t good enough.
The industry is being asked to measure all actions through the lens of Consumer Duty. If HMRC was to do likewise, there is no doubt this measure causes foreseeable harm and puts a barrier in the way of consumers pursuing their financial objectives.
Andrew Tully is technical director at Canada Life
HMRC are a ‘law unto themselves’ and their attitude is unacceptable regardless of the amount of interest they make out of unsuspecting taxpayers who also pay their wages.
Perhaps if everybody contacted their local paper then it would be another ‘gem’ to be highlighted by Govt.?