AJ Bell : Pension freedoms overtaxation bill nears £1bn as rising numbers access retirement pots during cost-of-living crisis

Pension freedoms overtaxation bill nears £1bn as rising numbers access retirement pots during cost-of-living crisis

Tom Selby

31 January 2023

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AJ Bell press comment -31 January 2023

• Savers have reclaimed £970 million in overtaxation on pension withdrawals since 2015, AJ Bell analysis of HMRC data reveals
• More than £45 million was repaid to 14,335 people overtaxed on pension withdrawals in October, November and December 2022 - the highest Q4 figure on record and third highest of any three-month period since April 2015 (141 (Newsletter 146 - January 2023 - GOV.UK (www.gov.uk))
• The average reclaim in Q4 2022 was £3,141, down slightly versus the previous quarter - suggesting more people are accessing smaller retirement pots
• Anyone who flexibly accesses taxable income from their pension will trigger the 'money purchase annual allowance', slashing their annual allowance from £40,000 to just £4,000
• Treasury under growing pressure to address the pension tax penalty facing older people who return to work

Tom Selby, head of retirement policy at AJ Bell, comments:

"As surging inflation eats into people's spending power, there is mounting evidence savers are turning to their retirement pots to make ends meet.

"We already know flexible pension withdrawals spiked in the early part of 2022, with £3.6 billion of retirement money accessed between 1 April and 30 June 2022 - a 23% increase compared to the same period in 2021¹.

"This is now filtering through into pensions overtaxation figures, with a staggering £45 million repaid to savers in the final three months of 2022 - the highest Q4 figure on record and third highest since the pension freedoms were introduced in April 2015.

"The total overtaxation figure has now reached £970 million and will inevitably pass the £1 billion landmark in 2023.

"Depressingly, the true scale of the issue is likely much higher as many of those who have been overtaxed - in particular, people on lower incomes who are less familiar with the self-assessment process - will not go through the official process of reclaiming the money they are owed. As a result, they will be reliant on HMRC putting them right.

"It is ridiculous the tax system operates in this way and scandalous that the Government has done nothing to address it almost eight years since the pension freedoms were introduced."

Pension tax penalty must be addressed

"Anyone who flexibly accesses taxable income from their pension will be clobbered by the 'money purchase annual allowance' (MPAA), reducing their annual allowance from £40,000 to just £4,000. They will also lose the ability to carry forward unused annual allowances from the three previous tax years.

"As more people access their pensions during the cost-of-living crisis, the MPAA will become an increasingly significant savings barrier, particularly for those considering returning to work.

"Given Chancellor Jeremy Hunt has made clear his desire for older workers to help plug gaps in the labour market, addressing the MPAA at the March Budget feels like a no-brainer. As a minimum, he should increase it to £10,000 - the level at which it was first introduced.

"Over the longer-term, the Government should explore ways to remove the MPAA altogether - a move which could help simplify the UK's overly complex pension tax system."

Why are savers overtaxed on pension withdrawals?

"Since 2015, the Revenue has chosen to tax the first flexible withdrawal someone makes in a tax year on a 'Month 1' basis.

"This means HMRC divides your usual tax allowances by 12 and applies them to the withdrawal, landing hard-working savers with shock tax bills often running into thousands of pounds.

"While those who take a regular income or make multiple withdrawals during the tax year should be put right automatically by HMRC, anyone who makes a single withdrawal will likely be left out of pocket.

"It is possible to get your money back within 30 days, but only if you fill out one of three HMRC forms to reclaim your money. If you don't, you are left relying on the efficiency of HMRC to repay you at the end of the tax year."

How to get your money back if you are overtaxed

If you are taking a steady stream of income via drawdown then you shouldn't need to take any action, as HMRC will adjust your tax code to ensure that over the course of the year you are taxed the correct amount.

However, if you make a single withdrawal then you will either need fill out one of three forms or rely on HMRC putting you in the correct position at the end of the tax year.

Which form you need to fill out will depend on how you have accessed your retirement pot:

• If you've emptied your pot by flexibly accessing your pension and are still working or receiving benefits, you should fill out form P53Z
• If you've emptied your pot by flexibly accessing your pension and aren't working or receiving benefits, you should fill out form P50Z
• If you've only flexibly accessed part of your pension pot then use form P55.

Provided you fill out the correct form HMRC says you should receive a refund of any overpaid tax within 30 days.

Source: AJ Bell analysis of HMRC data

Source: AJ Bell analysis of HMRC data

¹Private pension statistics commentary: September 2022 - GOV.UK (www.gov.uk)

Tom Selby Head of Retirement Policy

Tom Selby is a multi-award-winning former financial journalist, specialising in pensions and retirement issues. He spent almost six years at a leading adviser trade magazine, initially as Pensions Reporter before becoming Head of News in 2014. Tom joined AJ Bell as Senior Analyst in April 2016. He has a degree in Economics from Newcastle University.

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