Over half a million still overtaxed by thousands on pensions

HMRC has long been criticised for the way the system works – with some experts calling for major reform

Millions is still being refunded to people by HMRC in overpaid pension tax, as experts call for reform to the system.

New figures have revealed that more than half a million claims have now been made to claw back overpaid tax since 2015, with the total amount refunded approaching £1.5bn.

In the latest quarter alone, 12,767 repayment claims were processed, amounting to £48.7m – an average refund of nearly £4,000 per person. This brings the total tax repaid so far this year to around £92m.

Steve Webb, former pensions minister and now partner at consultancy LCP, has renewed calls for reform.

He said: “How longer will all of this go on? Ten years on from the introduction of pension freedoms, tens of thousands of people each year are still having to fill in forms to claim back overpaid tax on their pensions from HMRC.

“This is a system designed for the convenience of the tax office, not the taxpayer. Given that most people in retirement pay tax at the basic rate, it would not be difficult to have a system which got things right for most people most of the time, rather than making over-taxing people part of ‘business as usual’.

“It is time to that the whole system was simplified and made more predictable for pension savers looking to draw on their pensions.”

Under current rules, when people first access a defined contribution (DC) pension, the taxman often applies an “emergency” tax code on a one-off withdrawal, treating it as if the same amount will be taken every month.

This results in significant over-taxation in many cases. Although this money is eventually returned via HMRC’s annual reconciliation process, those wanting faster repayment must manually complete one of three forms.

The system has faced repeated criticism from experts but despite small recent tweaks by HMRC, including faster updating of tax codes once a pension is accessed, the core process remains unchanged.

Jon Greer, head of retirement policy at Quilter, echoed these concerns.

He said the latest figures show HMRC is still battling the “scourge” of tax overpayments on pension withdrawals.

Greer said: “The idea behind HMRC’s new tax coding process is that it should reduce the administrative burden on savers, while also minimising the number of overpayments being made in the first place.

“But the changes they made do not impact the taxation of the first pension payment and although it is early days, and the stats may include payments from the previous tax year, the change appears to be having minimal impact.

“Pension withdrawals are always going to be a challenge for a PAYE system that is designed for regular income.

“Many people now access their pension for a variety of reasons, be that regular income, gifting, emergencies or one-off payments and each of these could result in emergency tax codes being issued.”

David Brooks, head of policy at financial consultancy Broadstone, said the figures were “alarming” and showed the scale of the issue, but he welcomed the fact that improvements to the framework are on the way.

He said despite the changes made to help people get the correct tax code sooner, many people will still be caught by the existing rules and forced to reclaim overpaid tax, leaving what he described as a “dissatisfactory outcome”.

The first withdrawal of each tax year remains subject to the emergency tax treatment, which experts argue is precisely where most of the overpayments occur.

Reformers want a system that can better recognise one-off or irregular withdrawals and apply the correct rate of tax at source.

For those considering accessing their pension and affected by this “headache”, as Greer described it, they should seek guidance or where appropriate professional financial advice.

He added: “This will be key as this will ensure you make any withdrawals from a pension in the most tax efficient way, while also helping to calculate your exact liabilities.

“This new system will need some time to bed in and hopefully we do start to see the number of claims drop more significantly.”

An HMRC spokesperson said: “Nobody ultimately overpays tax as a result of taking advantage of pension flexibility.

“We will repay anyone who pays too much because they’re on an emergency tax code and individuals can claim a repayment earlier if they wish.”