Govt needs to urgently review taxation of pension freedoms withdrawals

Pension providers are calling on the government to urgently review its approach to the taxation of pension freedoms withdrawals in light of news that a record £54 million was repaid to savers who were overtaxed on withdrawals in the three months to September 2019.

A total of £535m has now been repaid to investors who have filled out the official reclaim forms since April 2015, while the average reclaim per investor breached £3,000 for the first time in the latest quarter.

HMRC revealed this week that over £30bn has been flexibly withdrawn from pensions since the introduction of pension freedoms in 2015. £2.4bn was withdrawn from pensions in the third quarter of 2019 by 327,000 individuals, a 21 per cent increase from the £2bn that was taken out during the same period in 2018.

Under current tax rules, when an individual withdraws money from their pension, HMRC assumes that the individual will make lots of withdrawals, therefore often venturing into the 40 per cent tax band. It pre-empts this estimation by applying an emergency tax code and taking a large amount of tax from the withdrawal. However, this assumption is often incorrect and individuals then have to fill in one of three different forms to get their money back, or wait until the tax return process at the end of the year to rectify the miscalculation.

AJ Bell senior analyst Tom Selby said that the figures showed that the tax system that sits alongside pension freedoms withdrawals was “simply not fit for purpose”, adding that as most people do not even fill out the forms to reclaim tax, the £535m figure was probably just the tip of “a sizeable iceberg”.

“People risk being left short of money as a result of HMRC’s approach and forced to either take out more cash from their pension, potentially paying extra tax in the process, or seeking the funds from elsewhere,” he said.

“This is a particular problem if someone has earmarked the withdrawal for something specific, such as helping their child buy a house or paying for long-term care for an elderly relative. Savers struggling to make ends meet as a result of being overtaxed could even be forced into the arms of a high cost lender.”

Royal London director of policy Steve Webb said that HMRC had now “outdone themselves” in setting a new record for tax repayments.

“It cannot be right that tens of thousands of people each year have too much tax taken out of their pension and then have the hassle of filling in a form to get back money that is rightfully theirs,” said Webb. “Whoever ends up running the country after the General Election needs to tell HMRC to stop this practice as a matter of urgency.”

The government’s own Office for Tax Simplification has called on HMRC to review the process of applying emergency tax codes to pension withdrawals, but HMRC has refused to act to date.

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