Pension freedoms withdrawals at beginning of tax year risk considerable over-taxation

Pension freedoms withdrawals in the new tax year are at greater risk of being overtaxed by thousands of pounds, with refunds taking up to 12 months, AJ Bell has warned.

Those experiencing over-taxed pension freedom withdrawals will have to wait at least 12 months to get their money back or contact HMRC to reclaim their cash, it has been highlighted. This can affect anyone who takes a taxable pension freedoms payment from the age of 55, either via a drawdown or uncrystallised funds pension lump sum withdrawal.

“Tens of thousands of people using the pension freedoms every month risk falling into this tax trap. On average, the level of over-taxation runs into thousands of pounds and for some it could be tens of thousands of pounds,” AJ Bell senior analyst Tom Selby said.

He noted that the over-taxation issue is at its “most acute” at the beginning of the tax year. If savers make a withdrawal and do not fill out the correct claim form will have to wait at least until April 2019 to get their funds back. “Even then, you are relying on the efficiency of HMRC to put you back in the position you should have been in in the first place.”

At present, an average overpayment is £2,420, with an average of only 10,500 official reclaim forms processed by HMRC each quarter; £283m in overpaid tax has been repaid to pension savers so far.

On ad-hoc freedoms withdrawals, HMRC expects providers to use an emergency ‘Month 1’ tax code, which provides savers with only one twelfth of the usual tax allowances available on the withdrawal. This leads to many savers being highly overtaxed.

“This is no small issue. According to HMRC data, around 140,000 pension pots have been accessed for the first time every quarter since the pension freedoms were introduced. The vast majority of these are likely to have been taxed on a ‘Month 1’ basis,” Selby explained.

For example, a £2,000 withdrawal would result in a 10.41 per cent tax rate under a Month 1 basis, rising to a 36.93 per cent tax rate for a £20,000 withdrawal.

Selby concluded: “This is not an academic problem either – savers accessing their pensions for the first time using the freedoms understandably expect to receive the correct amount of money. Many will have specific plans for their withdrawal, such as to pay down debt or fund long-term care for an elderly relative. For people like this, getting thousands of pounds too little will present a serious financial challenge.

“HMRC should, at the very least, consult on its approach to single pension freedoms withdrawals and review the risks it poses to savers. Allowing providers to apply a ‘Month 12’ tax code would be a more consumer-focused solution, with HMRC taking responsibility for recouping any underpaid tax,” he advised.

Different types of claims can be made for overpaid tax and are dependent on the nature of withdrawals savers have made and their personal circumstances. More information can be found on the government’s website.

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