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HMRC declares commitment to address pension tax overpayment fiasco, allowing retirees to recuperate millions in refunds
The ongoing ordeal of claiming pension tax refunds has gripped us for the last ten years, but finally, it seems like we might escape this tax purgatory. HMRC has announced they'll overhaul the beloved system starting from April onwards.
Every year, countless retirees get overtaxed on their pension withdrawals, and it's been a formidable trip to nab that refund from HMRC. Over the past five years alone, a staggering £1.37 billion has been clawed back by those overtaxed on pension withdrawals.
In the final months of 2024, an impressive 14,600 repayment claims were processed, totalling nearly £50 million!
For years, critics have denounced this mess as a "tax nightmare" and a "scandal," highlighting the rogue tax bill, which is no one's idea of a pleasant retirement welcome. But now, HMRC is promising to improve the system by ditching retirees from emergency tax codes swiftly and ensuring none of our folks get overtaxed.
Legendary pension consultant, Sir Steve Webb, partner at LCP and a past pensions minister, states that reforming this chaotic system feels like a monumental breakthrough after years of constantly complaining.
"Beholden thousands have had their pockets picked, jumping through hoops to reclaim their own coin. This new system should mean that far more people are swiftly transferred to the correct tax codes, avoiding further overtaxation," Webb asserts.
So, why do our pension withdrawals get larded with taxes? 🤑🤝
It's usually because we first clutch our pension pots at 55 (rising to 57 in 2028) and are slapped with an emergency rate of tax. But never fret, dear citizens, because pension savers are permitted to seize money from their self-managed pensions (SIPPs) and firm schemes as they please. So, for instance, if we were to snag £500 one month, £2,000 the next month, and nada for the rest of the year—you get the picture!
Pension withdrawals are subject to income tax, aside from the 25% tax-free cash. HMRC taxes the initial flexible withdrawal someone makes in a tax year using a "Month 1" basis. Which means the withdrawal is taxed as if that'll be our income every month for the rest of the tax year. Sadly, that can result in an excessive amount of tax being siphoned off our pension payouts.
The latest HMRC figures reveal that the average tax refund claimed is a hefty £3,390.
Tom Selby, director of public policy at AJ Bell, notes: "This likely just scrapes the surface, though, as it only catches those who fill in the relevant HMRC tax refund form. In reality, lots of folks, notably those on lower incomes who might not be as familiar with the self-assessment method, won't exercise the formal route to reclaiming their owed money."
What's HMRC spilling the beans about? 🤫📣
HMRC's secrets are out in a casual newsletter to pension schemes, where they revealed that starting from April 2025, they'll squash the tax overpayment and underpayment issues we face by refining how they use tax code information for retirees who are new to receiving private pensions.
Their plan includes automatically updating the tax code for us when we're on temporary tax codes, so we'll dodge overpayment or underpayment at the end of the year. The cherry on top? No need to contact HMRC; they'll inform us once our tax codes have been changed, whether it be via letter or digitally if we've signed up for the HMRC app or online paperless system.
Webb believes this change should hopefully diminish the complications we encounter when we attempt to seize our hard-earned dough. He adds that the reform will drastically reduce the need for year-end reconciliations or form-filling to claim back over-paid tax, particularly for those who make multiple withdrawals in a single year.
However, Selby warns that the reforms don't fully address our needs, as they won't benefit "those taking ad-hoc lump sums from their drawdown pot."
Jon Greer, head of retirement policy at the wealth manager Quilter, deems the planned reforms "promising," but adds that "it remains to be seen whether they'll fully address the complexities and inefficiencies of the current system."
How can we pensioners snatch our tax refunds? 🏋️♂️💰
If you're nabbing a steady income via drawdown, you shouldn't need to lift a finger, as HMRC will adjust your tax code to ensure the correct tax is levied on you throughout the year.
But alas, if you're hit with an emergency tax bill due to a one-off withdrawal or frequent withdrawals, you have two options: complete a form and apply for a refund, or wait for HMRC to fix your situation at the end of the tax year.
Which form you need to fill out depends on how you've tapped into your pension pot:
- If you've siphoned your pot by flexibly accessing your pension and are still working or claiming benefits, you should fill out form P53Z.
- If you've siphoned your pot by flexibly accessing your pension and aren't working or claiming benefits, you should fill out form P50Z.
- If you've only flexibly tapped your pension pot, use form P55.
Refunds are paid within 30 days and are sent straight to your bank account.
- The promised reforms by HMRC, including the refinement of tax code information for new private pension recipients, may significantly reduce the need for personal-finance-related form-filling to claim back overpaid taxes, particularly for those making multiple withdrawals in a year.
- Amid the ongoing overhaul of the pension system by HMRC, personal-finance experts suggest that retirees should carefully consider their pension withdrawals and plan for potential tax implications, as moves such as seizing money from self-managed pensions (SIPPs) can be subject to income tax, even though the first 25% is tax-free.
