Pension flexibility proves taxing

Lump sum withdrawals under pension flexibility rules are resulting in over-paid tax as a result of the use of emergency tax codes, it has been revealed.

So if you are thinking about using pension flexibility, it really pays to take advice before asking for the payment.

Recent statistics from the taxman have highlighted the over-taxation of some pension benefits.

More than a million people have received flexible pension payments thanks to the rules introduced just over four years ago.

HMRC’s most recent statistics, to the end of March 2019, show that 1,113,000 people have withdrawn more than £25,600m from their pensions, across 6,136,000 payments.

The amounts withdrawn and the number of payments have both increased each tax year since the ‘freedom’ rules were introduced. In 2018/19 there were over 2,400,000 payments totalling £8,180m.

However, the system is causing some problems for HMRC. In the first quarter of 2019 HMRC refunded £31.1m of overpaid tax to more than 12,500 people.

And it has also emerged that it has given back more than £433m to taxpayers since the introduction of the pension freedoms.

The over-collection is a result of HMRC’s insistence on using emergency tax codes where a pension provider does not have a current tax code for the individual, which is usually the case on a first withdrawal.

More often than not, emergency tax codes create too high a deduction. The excess tax can be reclaimed and HMRC has created dedicated forms to speed up the repayment process.

In theory if no reclaim is made, the tax should eventually be refunded once HMRC undertakes its end of year reconciliation – but that could mean waiting more than 12 months if the payment is taken early in the tax year.

In some circumstances the emergency code issue can be sidestepped, but if it cannot, then you need to be aware of what you will receive initially and the process of reclaiming what you’re owed.

There have been growing calls for the policy to be changed; however, last June, HMRC said it had been reviewing the process for flexible pension drawdown payments, but it had concluded “that any changes at the current time would not significantly improve the tax position for the majority of recipients of a flexible drawdown payment, when compared to the process currently in place”.

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