Why people have been taxed £1.3bn too much on their pensions

New figures show that people have been taxed £57m too much on withdrawals from their pensions in the past three months, as the total amount of over-taxation hits almost £1.3bn.

Data from HMRC shows that in April, May and June over 16,000 reclaim forms were processed during the quarter from people who had been hit with higher tax bills than necessary on their pension withdrawals, with an average reclaim of £3,540 – the third highest figure on record.

The true over-taxation number will likely be substantially higher. In particular, people on lower incomes who are less familiar with the self-assessment system might be less likely to go through the official process of reclaiming the money they are owed. As a result, they will be reliant on HMRC putting their affairs in order.

But why are pensioners being taxed too much and what can you do about it?

Why are savers overtaxed on pension withdrawals?

Since 2015, HMRC has chosen to tax the first flexible withdrawal from a pension that someone makes in a tax year on a ‘Month 1’ basis. This means HMRC divides your usual tax allowances by 12 and applies them to the withdrawal, landing hard-working savers with shock tax bills often running into thousands of pounds.

While those who take a regular income or make multiple withdrawals during the tax year should be put right automatically by HMRC, anyone who makes a single withdrawal will likely be left out of pocket.

It is possible to get your money back within 30 days, but only if you fill out one of three HMRC forms to reclaim your money. If you don’t, you are left relying on the efficiency of HMRC to repay you at the end of the tax year.

One way savers planning to take a single withdrawal in a tax year can potentially avoid the shock of a big overtaxation bill is by taking a notional withdrawal first. This should mean HMRC is able to apply the correct tax code to the second, larger withdrawal.

How to get your money back if you are overtaxed

If you are taking a steady stream of income via drawdown then you shouldn’t need to take any action, as HMRC will adjust your tax code to ensure that over the course of the year you are taxed the correct amount. 

However, if you make a single withdrawal then you will either need to fill out one of three forms or rely on HMRC putting you in the correct position at the end of the tax year.

Which form you need to fill out will depend on how you have accessed your retirement pot:

• If you’ve emptied your pot by flexibly accessing your pension and are still working or receiving benefits, you should fill out form P53Z
• If you’ve emptied your pot by flexibly accessing your pension and aren’t working or receiving benefits, you should fill out form P50Z
• If you’ve only flexibly accessed part of your pension pot then use form P55

Provided you fill out the correct form HMRC says, you should receive a refund of any overpaid tax within 30 days.