According to a recent BBC report, HMRC had to refund £160 million last year to people who had flexibly withdrawn money from their pension fund and overpaid tax as a result. 

That figure relates to those who submitted a claim for a refund of overpaid tax. It is likely that there are many others who may not realise they have overpaid, and will only be refunded if and when they complete their self-assessment tax return. 

The total amount refunded since 2015 is in excess of £1 billion.

Unless you are very careful, it is easy to fall into a trap and pay more tax than necessary when you first take money from your fund. 

While this is not something you will likely need to worry about during your playing career, it could become an issue when you start to access your pension savings.

So, in this article, read about how such an over-collection of tax is possible, how to avoid an unnecessary pension tax bill yourself, and how to claim a refund if you are affected.

Changes to pension rules have created flexibility for retirees

Pension rules introduced in 2015, relating to how and when you can draw from your pension fund, allow a remarkable amount of flexibility. 

In fact, this legislation has effectively resulted in only two restrictions:

  • You cannot start drawing money until you reach age 55, rising to age 57 in 2028
  • You can only take 25% of your fund free of tax, and the balance will effectively be treated as income and taxed accordingly thereafter.

While such flexibility is one of the main benefits of pensions, it is now thought that the overpayment problems have been created because HMRC systems have not been updated to deal with the changes that have occurred. 

The initial withdrawal from your fund can result in you being charged on an emergency tax code

The reason for the over-collection, resulting in many people needing to go through the process of claiming a refund, is HMRC not being aware of how this will affect your overall income in a tax year. 

Because of this uncertainty, when you first take a lump sum out of your pension, you are likely to be charged on an “emergency” tax rate.

This effectively treats any lump sum as monthly income and assumes that you will be taking the same amount in each subsequent month. Your tax code is assessed accordingly, with the result that you are likely to be paying a higher rate of tax than you ought to be. 

It is then your responsibility to claim back this overpayment, through a process that can take some time and potentially leave you out of pocket. 

There are ways to avoid overpayment 

If you plan ahead and are careful when you make initial withdrawals from your fund, you can improve your chances of avoiding being affected in the way you have read about here. 

For example, just taking a small amount of income initially, such as £100, will generate a tax code from HMRC that your pension provider will apply to any subsequent withdrawals. For such a small sum, this code is unlikely to look much different to your existing one. 

That will result in the tax you are liable for being far more accurate, and result in you being less likely to have to go through the process of having to request a refund. 

How you can claim money back

If you do end up overpaying tax, you could wait until you complete your next self-assessment tax return. But it could make more sense to claim it back straight away, so you have access to the money far more quickly. 

To do this, you will need to complete an HMRC form based on your particular circumstances. 

There are three such forms, which you can find on the government website:

  • P50Z, for if you have taken your entire pension fund as a lump sum and have no other income in the tax year
  • P53Z, for if you have taken your entire fund as a lump sum and do have other taxable income
  • P55, for if you have withdrawn only part of your pot and you are not taking regular payments.

Once you submit the form with the correct details, HMRC will normally arrange a refund (if appropriate) within 30 days. This is an average timescale, so you may need to wait longer than that. 

It is important to plan your retirement income carefully

As you read in the introduction to this article, this is probably not a problem you will need to worry about during your playing career. However, as you get closer to the time when you will want to start drawing money from your pension fund, it is clearly an issue you will need to plan for. 

As a result of any potential overpayment, with all the resulting time and effort required to obtain a refund, it makes sense to plan withdrawals from your fund carefully. 

Doing this will mean that you can reduce the amount you may need to claim back, or avoid having to make a claim entirely.

Having to make a claim in this way and being on a temporary tax code could easily result in your ongoing income being affected. Furthermore, you could find yourself left with a shortfall for several months.

Given this, it makes sound financial sense to seek expert help, rather than taking a DIY approach, which could result in a costly error. 

Yet, research published by Actuarial Post confirmed that in the 2021/22 tax year, only 1 in 3 people took financial advice before starting to draw from their fund. 

To help mitigate against the effects of an emergency tax code, it is important to be aware of this possibility and plan ahead wherever possible.

Get in touch

If you have queries about planning your income in retirement, then please do get in touch with us at DBL Asset Management.

Email or call 01625 529 499 to speak to us today.

Please note

This article is for information only. Please do not act based on anything you might read in this article. 

A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. 

The Financial Conduct Authority does not regulate tax planning.