By James Jones-Tinsley, Self-Invested Pensions Technical Specialist at Barnett Waddingham
The reason for discussing it was because, in light of mounting criticism over the amount of income tax being deducted from the initial amount of pensions income being ‘flexibly accessed’, HMRC had carried out a review of their prevailing process to see if it could be improved.
Perhaps unsurprisingly, the outcome of that review determined that no changes were needed to their processes, and the reason given for that decision was that it prevented people from paying too little tax.
To my knowledge, despite seven years elapsing since that decision, no such review has been carried out again.
Instead, we have succumbed to a quarterly update in HMRC’s Pension Scheme Newsletters of how much overpaid income tax has been returned to individuals over the course of the preceding three months.
And, as each quarter passes, it makes for increasingly eye-watering reading. For example, in their second newsletter issued in April, more than £42 million of overpaid income tax was returned to individuals during the first quarter of 2024.
For the 2023/24 tax year as a whole, a record £198 million was repaid on flexible pension withdrawals.
And - provided you are sat down before reading the rest of this sentence - over £1.2 billion has been repaid by HMRC in overpaid tax on flexible pension withdrawals, since the dawn of the pension freedoms nine years ago.
If HMRC was a private sector business, it would quickly – and deservedly – be hauled over the coals for effectively generating an interest-free loan for itself through all the tax overpayments received, until such time as those overpayments were claimed and ultimately repaid.
And the process of claiming back those overpayments can only be described, by adopting my Yorkshire vernacular, as “a right faff”!
There are two options; either wait until after the end of the tax year in which you took the withdrawal, (which isn’t ideal if you needed all of the money urgently and withdrew the income amount shortly after 6 April), or go to the trouble of completing one of three HMRC forms – namely, a P55, P53Z or P50Z (depending on the type of withdrawal) – which allow individuals to claim back the overpaid tax during the tax-year of withdrawal.
To put this form-filling into context, the latest figures from HMRC showed that more than 13,000 claim forms were processed between January and March 2024 alone.
Surely, the time and effort expended by both the claiming individuals and the administrators within HMRC could be circumnavigated by adopting a different means of collecting the tax due on a pension income withdrawal?
Why does the overpayment arise in the first place? It’s because individuals are placed on an emergency tax code when they first flexibly withdraw income from their pension arrangement.
And until they – and their pension administrators - receive an updated tax code from HMRC, the underlying assumption made by HMRC is that the first withdrawal – regardless of quantum – is what they will be withdrawing each month for the remainder of the tax year.
In most cases, this assumption is incorrect, and results in too much income tax being deducted at source.
I don’t think the word ‘archaic’ does this prevailing situation justice, and I sincerely hope that, following the forthcoming general election, the new parliamentary administration swiftly implements a much-needed overhaul of this pitiful state of affairs.
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