Pension Freedoms was a big change in the way you can take pension income, coming in to effect in April 2015. You are able to withdraw as much as you like (from age 55) and the popularity of doing so has been increasing ever since; In total, figures from HMRC show that £17.5 billion has been withdrawn.
Issues have since arisen due to the way withdrawals above the 25% tax-free element are dealt with; they are added to your other income in the year and income tax applied, which sounds simple enough, but the pay-as-you-earn (PAYE) system HMRC use isn’t designed for large ad-hoc sums. Thanks to the popularity of Pension Freedoms, people have had to reclaim more than £300 million in overpayments since 2015. What’s more concerning, how many people have failed to notice and have not made a claim?


By default, pension income is likely to be taxed on an emergency rate, as your pension provider won’t know your tax code or details of other income. The PAYE system also assumes that you will be receiving the same level of income every month for a year, which, if you’re making a large lump sum pension withdrawal, is obviously not the case.
Steve Webb, Director of Policy at Royal London, said; “HMRC is clearly out of control. It operates a system of ‘tax first, ask questions later’, presumably so that the Government can enjoy some extra interest until the money is claimed back. It is time to speak up for ordinary citizens who are forced to pay excessive amounts of tax and then go through the hassle of claiming it back. This is a system built around the needs of the Treasury and the bureaucracy, not one which puts people first.”
Statistics from HMRC regarding the number of claims are a reminder of the complexity of the process, with over 10,000 people in the first quarter of 2018 having to submit one of three forms. Specifically;

  • 988 people completed form P50Z (to claim a tax refund if you’ve stopped work and flexibly accessed your entire pension)
  • 6,218 had submitted form P53Z (to claim a tax refund when you’ve taken your entire pension as a lump sum and also have other income)
  • 3,448 people completed form P55 (to reclaim an overpayment of tax when you’ve flexibly accessed only part of your pension fund)

By far the most popular are people withdrawing their entire pension whilst still receiving other income, most likely from employment, so the likelihood of falling into a higher income tax bracket is increased.
Webb continued in a follow-up statement; “HMRC is perfectly happy to over-tax tens of thousands of people each year and make them jump through hoops… This is a system run for the convenience of HMRC, not the taxpayer.”
Certainly, it’s a big inconvenience for you and I, but other than a waste of around six weeks making the claim, what are the other implications?

Lost opportunities

If there is a specific amount of money required, to pay for home improvements, for example, you may have to withdraw more than necessary to make up the (albeit temporary) shortfall. This could result in potentially lost investment gains.
The problem is that when you begin to take flexible withdrawals the amount you can contribute back into your pension is heavily restricted, typically to a maximum of £4,000 a year. If your tax refund is more than £4,000 you would be unable to reinvest the whole sum in your pension that year. (This is a rule called the Money Purchase Annual Allowance, if you are concerned this could affect you please get in touch with one of our financial planners).
Reclaimed funds could be invested in other tax efficient savings such as a Stocks and Shares ISA, assuming you have not used your ISA allowance that year.

What’s being done?

Unfortunately, nothing by HMRC. Even after the Office of Tax Simplification (an advisory body to the Treasury) suggested a review, HMRC is not budging on the issue; deciding that the existing tax treatment of flexible pension withdrawals remains the most effective method and reduces the risk of underpaying. In other words, they would rather take too much than too little, and it remains your responsibility to organise a refund.

What can we do?

In a word; planning. If you are able to forward plan and predict your future needs you can tax-efficiently make withdrawals over a 12-month period, minimising the tax liability. In any circumstance, if you’re planning to utilise your pension, to understand the tax implications and the likely effect on your retirement income, it’s worth a chat with one of our Financial Planners.