The Office of Tax Simplification (OTS) has asked for a review in the way the emergency tax code is used for lump sum withdrawals from personal pensions.

In its paper Savings Income: Routes to Simplification released today, 25 May 2018, the OTS has urged HM Revenue and Customs to properly explain the “special tax treatment” of these payments to avoid “confusion” for people looking to withdraw.

Since the introduction of pensions freedoms in 2015 many over 55s have taken advantage of the flexibility to withdraw a lump sum form their pension savings.

The paper said: “More could be done to help people understand the tax implications of withdrawals from pension funds and the actions they may need to take.

“The OTS would like to explore this further with HMRC, in addition to working to identify options other than initial tax deduction using emergency tax codes on personal pension lump sums, which generally results in the deduction of too much tax when the payment is made.”

The issue itself stems from applying PAYE to pension income, from which the provider will use the number shown on a form P45 for the current tax year, information which is unlikely to be held at the time the lump sum is withdrawn, meaning an emergency tax code will be used.

“The fact that the taxation of pension lump sums is not easily understood by many recipients results in many queries as well as claims for repayment. It is quite possible that some pensioners do not make claims due to a lack of understanding of the correct tax treatment. A repayment after the end of the tax year would normally be made in these cases”, the report said.

According to the OTS, £37m of tax has been repaid following overpayments of the tax pension lump sum withdrawals since the April 2015 changes.

Aegon head of pensions, Kate Smith said: “This is really good news for those accessing the pension freedoms by taking a cash lump sum.

“The tax rules are far too complicated and the process for reclaiming overpaid tax is too convoluted. Government needs to find a pragmatic and straightforward solution that works for HMRC but crucially for the thousands of people taking lump sums from their pension pots.”

An AJ Bell survey of 370 people who have used pension freedoms found that 63 per cent assumed they had been taxed correctly, while 24 per cent said they didn’t know.

AJ Bell head of technical resources, Gareth James, said: “The reality is that the vast majority of these people will have been overtaxed on their first withdrawal so lots of them will be unaware that they have been over taxed and will not have put in a reclaim.”

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