Savers overtaxed while dipping into their pensions have reclaimed £600million from HM Revenue & Customs so far this year.
More than 10,000 people paid too much tax when they took money out of their pension, paying an average of £3,141 too much each, HMRC said. The rules allow savers aged 55 and over to withdraw 25% of their pension as a tax-free lump sum, and the rest as income, to which the usual tax rules apply: you get a £12,500 personal allowance each year and only pay tax on income above that.
The number of people making pension withdrawals increased 23% from January to the end of March, with 348,000 people withdrawing money. The average amount accessed was £7,100, a 3% drop compared with the same time last year.
Pensioners withdrawing lump sums, as opposed to a regular income, are more likely to be overtaxed under “month one” tax rules used by HMRC that mean even a £12,500 withdrawal can push someone into the higher-rate tax band. The full personal allowance isn’t applied to the withdrawal, but only one month’s worth. On a £12,500 withdrawal, this gives a tax-free amount of £1,042 with £3,125 taxed at the basic rate of 20%, and the rest taxed at the higher rate of 40%.
HMRC will either issue a refund at the end of the tax year, or pensioners can claim the money back by submitting a P55, P53Z or P50Z form.
“People dipping into their pensions for the first time as a result of Covid-19 risk getting thousands of pounds less than expected due to HMRC’s emergency taxation policy on single withdrawals,” says Tom Selby, a senior analyst at the investment manager AJ Bell.