HMRC Takes Action to Fix Pension Tax Overpayments
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HMRC has said it will reform the way it taxes pension withdrawals that leads to people being charged excessive tax.
The issue has plagued pension holders since the introduction of pension freedoms in 2015.
It affects defined contribution (DC) pension holders who reach pension freedom age – currently 55 years-old but set to increase to 57 in April 2028.
Pension freedoms allow DC pension holders to withdraw lump sums from the pot instead of having to buy a lifetime income policy such as an annuity.
The issue however emerges with how HMRC treats the lump sums for tax purposes. HMRC routinely misinterprets the withdrawal as the first of a recurring series and applies an ‘emergency’ tax code to the amount, which results in charging far more tax than is necessary.
The latest figures from HMRC itself show it overcharged pensioners £49.5 million in taxes between 1 October 2024 and 31 December 2024.
Overcharged pensioners have had refunds amounting to £1.37 billion since the pension freedoms system was established, according to Steve Webb, former pensions minister and partner at LCP.
Webb comments: “It is great news that at long last HMRC has listened to the voices of ordinary taxpayers and changed this scandalous system. For too long, hundreds of thousands of people have been overtaxed and had to jump through hoops to claim back their own money.
“This new system should mean that far more people are quickly moved on to the correct tax code and no longer end up with an overpayment of tax. The tax system is complex enough as it is, and this change should hopefully reduce the complications which pension savers face when they try to access their hard-earned cash”.
Pension withdrawal changes
Currently anyone withdrawing lump sums from pensions needs to keep a careful eye on how much tax they pay and claim a refund if they have been overtaxed. This can be done on the HMRC website.
Those making withdrawals should also be aware that underpayment is also possible which could leave unexpected liabilities to pay at the end of the tax year.
However, this is set to end with HMRC to implement a new system that automatically establishes the correct tax code, which means anyone withdrawing needn’t worry about overtaxation.
HMRC has explained in a statement: “We will automatically update the tax code for customers who are on a temporary tax code and would benefit from being on a cumulative code — this means they’ll avoid an overpayment or underpayment at the end of the year.
“There is no need to contact HMRC and once a tax code has been changed, we’ll inform customers by letter or digitally if they’ve signed up for paperless in the HMRC app or online”.
The changes will take affect from April 2024.
If you have any concerns about how much tax you might be liable for with your pension, it is important to consult with an adviser to ensure you’re clear on liabilities and entitlements.
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