Tens of thousands who accessed pension freedoms have overpaid tax and not reclaimed it says AJ Bell

6th April 2017

Tens of thousands of people who have used the pension freedoms since they came into effect two years ago have failed to reclaim millions of pounds in overpaid tax that would have been charged on their first withdrawals.

When someone takes their first flexible withdrawal from their pension fund using the freedoms, it is highly likely that their pension provider will not have a tax code for them.  HMRC rules require the pension provider to apply tax on the basis that only part of the full tax year allowances are given – known as a ‘month 1’ basis.

The withdrawal is counted as if it is a monthly withdrawal that will be made every month during the year, rather than the one off withdrawal it will be in many cases.  The tax is therefore calculated based on a much higher annual withdrawal than the investor actually takes.

Someone withdrawing £10,000 from their pension deliberately to keep themselves under the personal allowance would have expected to pay no tax but they may pay £3,099 in tax.  This is because under a month 1 basis it would be treated as the first of twelve £10,000 withdrawals and tax would be calculated based on £120,000 being withdrawn throughout the year.

The table below shows the different amounts of tax people could have paid under a month 1 basis compared to what they might have expected to pay.

Withdrawal amount Tax due for a basic rate taxpayer if a single withdrawal Tax taken under Month 1 basis
£2,000 £0 £216.40
£5,000 £0 £1,099.46
£10,000 £0 £3,099.46
£15,000 £798.00 £5,178.56
£40,000 £5,798.00 £16,428.56

This tax can be reclaimed from HMRC but analysis of HMRC and FCA pension freedoms data shows that far fewer people have made the reclaim than have accessed the pension freedoms.

The FCA data shows that since the pension freedoms were introduced in April 2015, an average of 139,000* pension pots per quarter have been accessed for the first time using flexi-access drawdown or a lump sum payment.  The majority of these initial withdrawals are likely to have been taxed on a month 1 basis under HMRC rules.

However, HMRC data for 2016 shows that on average only 10,998** reclaims for overpaid tax have been made per quarter.  The total value of tax repaid by HMRC during 2016 was £108 million, a figure dwarfed by the £2.6 billion the Government is now expecting to receive during the first two years of pension freedoms.

Tom Selby, senior analyst at AJ Bell, says: “HMRCs insistence that an emergency tax code must be applied to pension freedom withdrawals means tens of thousands of people will have paid too much tax on their withdrawals yet very few of them have reclaimed this tax.  This might be because they don’t know they have paid too much tax or the process to reclaim it just seemed too complicated.  Whatever the reason, there is likely to be millions of pounds sat with HMRC that could be legitimately reclaimed. It is up to individuals to check whether they have paid too much tax and to make a claim, they are unlikely to get any help from the Government.”

How to make a reclaim

How people make a claim for any overpaid tax depends on the nature of the withdrawals they have made from their pension and their personal circumstances.

The Government website – https://www.gov.uk/claim-tax-refund/you-get-a-pension

*Source – FCA data bulletin: Issue 8 – https://www.fca.org.uk/publications/data/data-bulletin-issue-8

**Source – Pension Scheme Newsletters 78, 80, 82 and 84 – https://www.gov.uk/government/collections/hm-revenue-and-customs-pension-schemes-newsletters

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