“The hardest thing in the world to understand is the income tax.”“The hardest thing in the world to understand is the income tax.”
When Albert Einstein said this, he had already developed the theory of relativity, and established himself as one of the brightest minds in modern physics.
If Einstein found tax complicated, it’s no wonder that an estimated 200,000 pensioners have overpaid tax since the Pension Freedoms were introduced in 2015. Research from The Telegraph suggests up to 200,000 over-55s are due a rebate, all of who aren’t being proactively notified by H M Revenue & Customs (HMRC). Whilst there are numerous ways to check if you have overpaid tax, experts are calling for an overhaul of the system, as many still remain unaware.
How have people been overtaxed?
Put simply, due to a quirk in the way tax codes are applied to pensions.
You can take the first 25% of your pension pot as a tax-free lump sum after the age of 55. Any further withdrawals, whether regular or one-off, are potentially subject to income tax. It is these on off withdrawals that are causing some pensioners to overpay tax.
However, when one-off withdrawals are being made, a ‘month 1’ tax code is being applied that means HMRC interprets it as the first of regular monthly withdrawals. This essentially means that if somebody takes £1,000 out of their pension pot, HMRC would assume an annual income of £12,000, charging tax for the £500 that falls outside the Personal Allowance.
This ‘month 1’ code is being applied due to HMRC instructions that require pension providers to do so as default. AJ Bell calculated that a single withdrawal of £10,000, which should be tax free providing no other income is taken, would be taxed at £3,099.46 if the ‘month 1 code’ was applied.
Tom Selby, Senior Analyst at AJ Bell, commented: “These figures show the extent of the pension freedoms tax problem. Thousands of people who think they are using the new regime sensibly will have been hit with shock bills, and this will continue unless HMRC rethinks its draconian application of ‘Month 1’ tax.” (source: The Telegraph )
Sir Steve Webb, a director at Royal London, stated: “It cannot be acceptable to take thousands of pounds per person in excess taxes, and then expect people to have to claim that money back. The rules need to be changed so that only basic rate tax is deducted and any extra tax due is collected through the normal tax return process. This would be a far fairer system.” (source: The Telegraph )
How do I know if I’ve been overtaxed?
According to data obtained from a Freedom of Information (FOI) request made by The Telegraph, 242,000 people made just one withdrawal in the 2016/17 tax year. The Government estimates that 42,700 people have claimed their money back, leaving nearly 200,000 unaccounted for.
Whilst HMRC have disputed the scale of these figures, they could not state what proportion of savers were paying the correct amount of tax. It is also unknown how long it will take for the system to correct errors not flagged by people themselves.
If you believe that you’ve been overtaxed, then there are a number of ways to reclaim the money. The nature of your withdrawals and your personal circumstances will affect which form you need to fill out:
- Form P50Z : If the payment used up your pension pot and you have no other income in the tax year
- Form P53Z : If the payment used up your pension pot and you have other taxable income
- Form P55 : If the payment didn’t use up your pension pot and you’re not taking regular payments (this form can only be used if your pension provider can’t refund you).
Some pension providers will pay you back automatically if they detect that an overpayment has been made. A P800 tax calculation may also be posted to you, with instructions to get a refund online, or a cheque.
More information can be found online here or can be requested by phone on: 0300 200 3300.
For more information about Pension Freedoms and how they can affect you, don’t hesitate to contact us on the number at the top of the page.
