Pensioners in the UK are facing significant overtaxation due to ‘inherent flaws’ in HMRC systems, with each affected individual being overcharged by an average of £3,691, new figures show.
Recent data from HMRC reveals that a staggering £44.3million was repaid to people who were overtaxed on pension withdrawals in the third quarter of 2024 alone.
This ongoing issue has resulted in over 12,000 repayment claims being processed between July and September 2024.
Overtaxation occurs due to HMRC’s use of emergency tax codes when processing pension withdrawals.
Their system treats a lump sum withdrawal as if it were a regular monthly payment, which results in them overcharging people. The issue stems from a mismatch between the PAYE system and the pension freedoms introduced in 2015.
Jon Greer, head of retirement policy at Quilter said: “The tax system’s inherent flaws place a heavy burden on retirees.
“The PAYE system, while effective for regular income, struggles to accommodate the way pensions are accessed under the freedoms introduced in 2015.”
The HMRC system treats a lump sum withdrawal as if it were a regular monthly payment, which results in them overcharging people
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Fortunately, pensioners can reclaim their overpaid tax. There are three forms they can use, which can be submitted to HMRC.
Once processed, refunds are paid directly into the claimant’s bank account. Alternatively, individuals can opt to wait until the end of the tax year for their refund.
Helen Morrissey, head of retirement analysis at Hargreaves Lansdown said: “You can try to mitigate this by making your first pension withdrawal a small one if possible.
“If you do get landed with a bill, then you can get it rectified quickly by filling out a form and getting your money back as soon as possible.”
She explained that although the money will get refunded, many of those affected will not have been expecting the extra tax bill.
She added: “The extra tax bill will have come as a nasty shock. It may even have undermined plans that people had for the money in the short term, and it takes time to sort out.
“It’s an extra complexity that no one needs and should have been resolved many years ago.”
“The pension tax saga” drags on well into its ninth year with HMRC repaying almost £44.3million to people who were overtaxed on pension withdrawals over the quarter.
“It’s a situation that beggars belief with around £1.3billion in total being refunded so far.”
Greer warned that there may be a sharp rise in withdrawals in the next set of data, due to growing anxieties surrounding the upcoming budget.
Many savers may take unplanned action to take tax-free cash from their pension pots, fearing potential changes to pension taxation.
However, he emphasised the importance of seeking professional financial advice before making hasty decisions.
He said: “A rush to take money out could result in unnecessary tax liabilities, and careful planning is essential to avoid making decisions that might compromise their retirement plans.”
Greer continued: “Until the system is changed, we are likely to continue seeing many savers caught out and forced to reclaim significant sums of money.”
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Seeking professional financial advice can help structure withdrawals effectively and prevent unnecessary tax liabilities.
The Government and HMRC face mounting pressure to address these systemic flaws and provide a more efficient solution for pensioners especially as the Budget draws closer.
