Having saved into your pension throughout your career, perhaps the last thing you will want to face is a hefty tax charge when you start flexibly drawing your funds.
Yet, this is an event that befalls many retirees when they start accessing their pots. In fact, according to MoneyAge, HMRC repaid a record £198 million in the 2023/24 tax year to people who overpaid tax on flexible pension withdrawals.
Furthermore, HMRC has repaid more than £1.2 billion since it started refunding overpaid tax on flexible pension withdrawals nearly a decade ago.
While this tax is often refunded to you, it can be frustrating to not be able to access the money in your pension that you want to use to achieve your goals in retirement.
With this in mind, you may be wondering what you could do to avoid a tax charge so you can make the most of your pot.
The answer lies in what is known as an “emergency tax code”, and the charge could actually be entirely preventable.
Read on to find out how this works and what you can do about it.
Your pension income is taxable just like any other income
The origin of the issue surrounding emergency tax and flexible pension withdrawals is the fact that pension lump sums and income are taxable through PAYE, just as your earnings and income are throughout your career.
You can usually take the first 25% of your pension tax-free. After that, money taken from your pension is typically subject to Income Tax. The table below shows you the rates at which you could pay tax in the 2024/25 tax year, depending on how much you draw from your pension and other taxable sources:
| Band | Taxable income | Tax rate |
| Personal Allowance | Up to £12,570 | 0% |
| Basic rate | £12,570 to £50,270 | 20% |
| Higher rate | £50,271 to £125,140 | 40% |
| Additional rate | More than £125,140 | 45% |
So, once you have used up your 25% tax-free lump sum, the money that you draw from your pension could be taxable at these rates.
HMRC may use an emergency tax code when you first start drawing from your taxable pension
Crucially, you may pay a higher rate of tax than you expect when you start flexibly drawing the taxable element of your pension. That is because HMRC often applies a temporary emergency tax code to these initial withdrawals.
This may also be referred to as on a “month 1” (M1) basis, and could be applied to a single lump sum or ad hoc withdrawal, or the first payment of a regular income.
HMRC does this because, under the PAYE system, the withdrawal from the pension is treated as if it will continue to be paid each month. As a result, on the withdrawn amount, your pension provider will apply one-twelfth of the:
- Personal Allowance
- Basic- and higher-rate tax bands.
Any amount after this is subject to additional-rate tax at 45%.
Consider this example taken from abrdn. Imagine that you have a pension of £40,000. You draw 25% (£10,000) tax-free and then decide to take the remaining £30,000 straight away. Assume that you will not have any other source of income in this tax year.
That means you would pay:
- 0% tax on £1,047.50
- 20% tax on £3,141.67, a tax charge of £628.33
- 40% tax on £7,286.67, a tax charge of £2,914.67
- 45% tax on £18,524.16, a tax charge of £8,335.87.
In total, this would land you with a tax bill of £11,878.87, which is an effective tax rate of 39.6%. Bear in mind that if you are already an additional-rate taxpayer, this may actually be a lower rate. In this case, you may owe further tax in future.
In all likelihood, you will usually get some of this returned to you, as it is unlikely you will be taking £40,000 from your pension every month. So, HMRC will typically refund the overpaid tax. Furthermore, with effective tax planning, you can see the entire amount returned to you.
However, it does mean you would only receive £28,121.13 from your total £40,000 pension in the first instance, which could prevent you from achieving your goals in the short term.
Regardless, for most individuals, you can see why you may want to find a way to prevent paying this charge. Fortunately, there is a method that could allow you to do this.
Initially taking a small sum can help prevent overpaying in tax
One way to prevent being subject to the emergency tax code is to initially take a small amount from your taxable pension. HRMC then assume that you want to take some money from your pension and then continue doing so in the tax year.
For example, once you have taken your entire tax-free lump sum, you could then next draw a sum of £100. In turn, this generates a tax code that HMRC will pass to your pension provider that is then applied to your subsequent transactions. This can result in tax charges that are more accurate moving forward.
From there, you can then start flexibly drawing from your pension as and when you see fit, paying a tax rate more closely aligned with what you should be.
You can claim back overpaid tax if you do face a larger bill
If you ever find yourself placed on an emergency tax code then do not panic, as you can claim back overpaid tax from HMRC.
To do so, you can fill in one of the following forms, depending on the circumstances of your withdrawal:
- P50Z, used if you are taking your entire pension savings and will have no other sources of income for that tax year.
- P53Z, for if you plan to take your entire pot and will have further income in that tax year.
- P55, used when you take a portion of your pension savings but do not intend to draw more from your pot again this year.
If you do not plan to take any further payment in the tax year, you can instead wait until the end of the tax year, at which point any overpaid tax will usually be automatically refunded to you.
But, if you would prefer to access the overpaid tax sooner so you can start using this money to live your desired retirement lifestyle, you may want to claim it back.
Get in touch
As you can see, starting to draw your pension could be complicated, as could the process of trying to reclaim any overpaid tax.
So, if you would like support administering your retirement income, then please do get in touch with us at DBL Asset Management.
Email enquiries@dbl-am.com or call 01625 529 499 to speak to us today.
Please note
This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The Financial Conduct Authority does not regulate tax planning.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.
