Up to 100,000 savers are being taxed too much on their pension (2024)

Around100,000 savers could be out of pocket after being taxed too much on pension withdrawals, experts warn.

Savers owe income tax on money taken out of pension plans – apart from the first 25 per cent, which can cashed in tax-free.

But experts say pension firms are deducting too much tax because of a quirk in the tax rules.

The overpayments come about because, by default, the taxman expects savers to keep withdrawing the same amount every month.

So if someone withdrew £10,000, they would be treated as if they had an annual income of £120,000.

As a result, HM Revenue & Customs considers them a higher-rate taxpayer and bills them 40p in the pound – even if they are basic-rate taxpayers who should be billed just 20p per pound withdrawn.

Over the past two years, around 600,000 people have taken advantage of new rules that allow retirees to withdraw cash from their pension pots.

As many as 100,000 people have overpaid tax, according to research by investment firm AJ Bell.

Savers can submit a claim to HM Revenue & Customs and get a refund within 30 days, the taxman says.

But experts are warning that large numbers of older savers will have no idea that they may are owed money.

Those who fail to claim may have to wait months or even years for HMRC to notice the error and issue a tax refund.

In some cases, they may be left out of pocket indefinitely, the experts say.

Tom Selby, senior analyst at AJ Bell, said: ‘The pension freedoms tax rules are a nightmare for ordinary savers, who are being hammered with tax bills worth thousands of pounds and given no help to sort it out.

‘The 100,000 figure is our conservative estimate for the number of people affected.

‘Lower earners may be left out of pocket indefinitely if they fail to notice that they have overpaid or if they do not know how to navigate the fiendishly complex maze of forms to get their money back.’

Former pensions minister Baroness Ros Altmann said: ‘It’s ridiculous. A lot of people will struggle to reclaim their money or not know that they have overpaid.

‘This is clearly designed to get as much tax to the revenue as possible. The system works in favour of the taxman and against the individual pensioner.’

Under reforms introduced by former chancellor George Osborne in April 2015 savers reaching retirement are no longer forced to buy a policy known as an annuity, which guarantees a set income for life. Instead they can spend or invest their pension pot as they choose.

Since these new freedoms have been introduced, more than £9 billion has been withdrawn from pensions.

Many retirees have seized the opportunity to take out a one-off cash sum to pay for holidays, new cars or to redecorate their home.

However, thousands of these unsuspecting pensioners have paid far too much tax on these withdrawals.

Unless they have a customer’s P45 from their former employer, most pension companies use a so-called emergency tax code when someone makes their first withdrawal from a pension.

This code means the customer is taxed at the highest rate they could if they kept earning that amount every month for an entire year.

Someone who took out £10,000 from their pension, for example, would be treated as though they were living on an income of £120,000 a year.

This means HMRC would treat them like a higher earner.

Pensioners will not have to pay tax on 25 per cent of the payment - as there are existing rules that allow everyone to take a quarter of the fund tax-free.

But after that, tax will be charged at 40 per cent on the remaining £7,500.

As a result, they would overpay more than £3,000 if that was their only income for the year.

If they were a basic-rate 20 per cent taxpayer they would be paying around £1,500 too much, figures from AJ Bell show.

If people can provide their pension company with a P45 the correct amount of tax should be deducted.

But these forms are only issued when people leave employment or a pension has been paid out in full so thousands of people won’t have one.

A spokesman for HMRC said: ‘Claimants presenting their 2017/18 P45s to their pension providers will pay the correct tax. In the event that they don’t, any discrepancy will be settled within 30 days of HMRC being notified.’

To claim back overpaid tax visit www.gov.uk/claim-tax-refund/you-get-a-pension or call 0300 200 3300.