Returns on pension taxes: how to get your money back if you were overcharged

Since 2015, over £14 billion in pension tax overpayments have been recovered

Are you eligible for a refund?

More than 15,000 retirees received refunds from HMRC, which returned 44 million in overpayments for pension taxes in the first quarter of the year. The average repayment, according to the taxman's published figures, was 2,881.

As per AJ Bell's analysis of HMRC data, since the implementation of pension freedoms in April 2015, more than 1 point 4 billion has been distributed in tax refunds.

You may be wondering if you have been overcharged and why HMRC is taking out so much tax.

When you initially access your pension fund, there is a risk involved. HMRC taxes your initial withdrawal on a "month 1" basis, which means it makes the assumption that you will take out the same sum each month for the remainder of the tax year.

Some savers may actually take out a sizable sum in one sitting and then nothing in the months that follow. This kind of situation could lead to the application of an emergency tax code, which would result in a sizable tax overpayment.

How much tax might you be assessed?

Suppose you took out forty thousand dollars from your pension. How much tax might be assessed to you?

The first 30,000 would be subject to income tax, while the remaining 10,000 would be tax-free if you received the funds through an Uncrystallized Funds Pension Lump Sum (UFPLS) arrangement. You have the right to withdraw up to 25% of your pension fund as tax-free cash, which explains why.

"This would come to 11,879 in tax if this were treated on an emergency tax basis," stated Helen Morrissey, head of retirement analysis at Hargreaves Lansdown.

The reason for this is that when you are taxed in an emergency, you are treated as though the same amount would be collected each month. HMRC does not account for the one-time nature of this payment.

Consequently, one-twelfth of your personal allowance, one-twelfth of your basic-rate tax allowance, and one-twelfth of your higher-rate allowance are used to calculate your income tax payment. She continues, "The remaining amount will be subject to additional tax rates."

Although HMRC reforms should lessen overtaxation, you might still be affected.

The good news is that HMRC improved its system in April of this year to more rapidly transfer savers to the appropriate tax code.

According to consulting firm Lane Clark & Peacock (LCP), the modification should significantly lessen the need for year-end reconciliations or form filling in order to recover overpaid taxes, especially in cases where individuals make several withdrawals in a single year.

"The tax system is complicated enough as it is, and this change should hopefully reduce the complications which pension savers face when they try to access their hard-earned cash," also said Steve Webb, a former minister of pensions who is currently a partner at LCP.

However, due to restrictions, the improvements will only benefit those who receive a regular income. One-time withdrawers will still be subject to excessive taxes. AJ Bell's public policy director, Tom Selby, describes this as "unacceptable."

"On the cake commemorating ten years of pension freedoms, we have just blown out the candles," Selby stated. It's just not acceptable that the government hasn't changed the tax code to accommodate British citizens' flexible pension access starting at age 55 after all this time.

Make a very small withdrawal first to help savers avoid a surprise tax bill. Any further larger withdrawals should then be subject to the appropriate tax code applied by HMRC.

How to submit a pension tax return claim.

According to AJ Bell, you shouldn't have to do anything if you are receiving a consistent income stream through pension drawdown. Throughout the year, HMRC should modify your tax code to make sure you have paid the right total amount of tax.

You can file a form to recover the overpaid tax if you make an ad hoc, one-time withdrawal. Usually, a refund is given within 30 days. One of three forms must be chosen.

P55: If you have only used a portion of your pension fund, select this option. P53Z: If you are still employed or receiving benefits after depleting your pension fund, select this option. If you have used up all of your money but are no longer employed or receiving benefits, go with P50Z. The government's website has these forms.

If not, you can wait for HMRC to make amends at the end of the tax year, when they ought to automatically reimburse you for any excess money you paid. Instead of depending solely on the taxman, it is always worthwhile to confirm that this has been completed correctly.

HM Revenue and Customs: Learn More.