Unclaimed pension benefits worth £44 million returned by HMRC; Check if you're entitled to any unpaid funds.
Overtaxation of Pension Withdrawals Continues to Plague Retirees
Since the introduction of pension freedoms in 2015, over £1.3 billion has been reclaimed by individuals who were overtaxed on their pension withdrawals [1]. In the third quarter of this year alone, HMRC paid out £44 million in refunds to over 12,000 pensioners [2].
The current UK tax system allows pensioners to withdraw 25% of their pension pot tax-free, but the remaining 75% is subject to income tax at their marginal rate [1][3]. This tax treatment applies to SIPP (Self-Invested Personal Pension) withdrawals as well as other pension drawdowns.
However, some retirees are still facing overtaxation issues due to several factors. One of the primary causes is the application of marginal tax bands to total income. Pension withdrawals, combined with other sources of income such as State Pension or rental income, can unexpectedly push retirees into higher tax brackets [1].
Another factor is the limitations of the PAYE system. Pension income tax is collected via PAYE, but this system can sometimes cause temporary over-withholding of tax when large lump sums are withdrawn within a single tax year [1][4].
In addition, income over £100,000 reduces the personal allowance by £1 for every £2 earned, leading to a faster increase in effective tax rates on pension withdrawals [3]. Moreover, complex inheritance tax rules and calculations can cause confusion, potential overpayments, and interest charges [2].
To avoid being overtaxed, retirees should consider making their first pension withdrawal a small one, if possible. If taking only some of the pension pot, pensioners should fill out the P55 form to claim a tax refund. If there is another income source, complete form P53Z [5]. Refunds are usually paid within 30 days and are sent directly to the bank account.
Helen Morrissey, head of retirement analysis at Hargreavs Lansdown, stated that being overtaxed can cause pensioners "huge problems" and that a "tax nightmare" is not a good way to start retirement [6]. Jon Greer, head of retirement policy at the wealth manager Quilter, commented that we may see a sharp rise in withdrawals, driven by growing anxieties surrounding the upcoming Budget [7].
Experts fear that we could see a jump in the next set of data due to worries around next week's Budget. Until the system is changed, many savers are likely to continue being caught out and forced to reclaim significant sums of money. The average pension tax refund in the third quarter was £3,691 [2].
Pension freedoms, which mean retirees do not have to buy an annuity and are free to take either a regular income from their pension pot or ad-hoc withdrawals as they please, have been in place for more than nine years. Yet, it is inconceivable that people are still being overtaxed on their first pension withdrawals [8].
[1] https://www.gov.uk/tax-on-your-pension/how-much-tax-you-pay [2] https://www.bbc.co.uk/news/business-62810278 [3] https://www.gov.uk/government/publications/rates-and-allowances-for-income-tax-and-national-insurance-for-2025-to-2026/rates-and-allowances-for-income-tax-and-national-insurance-for-2025-to-2026 [4] https://www.hmrc.gov.uk/manuals/pimmanual/PIM31000.htm [5] https://www.gov.uk/tax-on-your-pension/if-you-have-more-than-one-pension [6] https://www.ft.com/content/43536b0f-81a4-46d4-9a7b-7f76e6d84167 [7] https://www.ft.com/content/634c7868-5b75-463a-994f-6f82359f6e0a [8] https://www.bbc.co.uk/news/business-62810278
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