Over-taxation on pension withdrawals 'more penal' during lockdown - Webb

HMRC’s over-taxing of pension withdrawals is “set to get more penal” during the lockdown period, according to Lane Clark and Peacock (LCP) partner, Steve Webb.

Analysis by the firm revealed that ‘over-taxation’, usually occurring when savers choose to take money flexibly from their pension, will likely become more draconian throughout the current crisis as more savers look to their pension to supplement income.

Webb called on HMRC to rethink the taxation process for these types of withdrawals as a "matter of urgency", stressing that the current crisis means people are already "hard pressed", with over-taxation forcing savers to claim back payments they never owed in the first place.

The former Pensions Minister drew attention to the impact on those savers who may have lost their jobs or suffered wage cuts, and therefore will have a reduced taxable income in 2020/21.

“As a result," he explained, "they should be paying less tax on these withdrawals. But HMRC is going to carry on taking exactly the same amount of tax upfront as it has always done."

Furthermore, recent HMRC statistics revealed that a record number, roughly a third of a million, people flexibly withdrew from their pension in the first quarter of 2020 alone.

Meanwhile, in the same period, HMRC processed over 10,000 claims from people who had reclaimed the overpaid tax as soon as it was deducted, with taxpayers receiving an average back of over £3,000.

HMRC already had to repay over £600m in over-paid tax on pension withdrawals since 2015, with £32.7m paid in Q1 of 2020 alone.

Webb, added: “In my view, it is already unacceptable that HMRC routinely over-taxes thousands of people on one-off withdrawals from their pension pots, leaving them to fill in forms to claw back the excess tax that they have paid.

“But in the current crisis, this system will be even more penal. Lots of people who lose their jobs or suffer wage cuts will have reduced taxable income in 2020/21.

“This system has to change. Whilst it is far from ideal if individuals feel they have no choice but to access their pensions to support them through the current crisis, the very least the authorities should do is allow fairer tax deductions upfront on them.

"The system of ‘emergency tax’ on one-off withdrawals from pension pots has already been widely criticised and it now looks unfit for purpose in the current crisis. HMRC should think again as a matter of urgency."

The issue generally occurs when members flexibly withdraw from their pension, with HMRC requiring the use of an 'emergency tax code' for this type of transaction.

This essentially taxes the person upfront as if they were going to make repeated withdrawals, rather than a one-off sum, with 'excess tax' from this having to be manually claimed back by savers.

For instance, if a member with a pension pot of £40,000 withdrew £10,000, and assuming the individual is a basic rate tax payer, the remaining taxable balance should be taxed at 20 per cent, a tax charge of £6,000.

However, in reality, the pension scheme would currently have to deduct almost £12,000, around double the correct figure.

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