New figures have revealed that more than half a million claims have now been made to claw back overpaid tax since 2015, with the total amount refunded approaching £1.5bn.
Steve Webb, former pensions minister and now partner at consultancy LCP, has renewed calls for reform.
“This is a system designed for the convenience of the tax office, not the taxpayer. Given that most people in retirement pay tax at the basic rate, it would not be difficult to have a system which got things right for most people most of the time, rather than making over-taxing people part of ‘business as usual’.
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Under current rules, when people first access a defined contribution (DC) pension, the taxman often applies an “emergency” tax code on a one-off withdrawal, treating it as if the same amount will be taken every month.
The system has faced repeated criticism from experts but despite small recent tweaks by HMRC, including faster updating of tax codes once a pension is accessed, the core process remains unchanged.
He said the latest figures show HMRC is still battling the “scourge” of tax overpayments on pension withdrawals.
“But the changes they made do not impact the taxation of the first pension payment and although it is early days, and the stats may include payments from the previous tax year, the change appears to be having minimal impact.
“Many people now access their pension for a variety of reasons, be that regular income, gifting, emergencies or one-off payments and each of these could result in emergency tax codes being issued.”
He said despite the changes made to help people get the correct tax code sooner, many people will still be caught by the existing rules and forced to reclaim overpaid tax, leaving what he described as a “dissatisfactory outcome”.
Reformers want a system that can better recognise one-off or irregular withdrawals and apply the correct rate of tax at source.
He added: “This will be key as this will ensure you make any withdrawals from a pension in the most tax efficient way, while also helping to calculate your exact liabilities.
An HMRC spokesperson said: “Nobody ultimately overpays tax as a result of taking advantage of pension flexibility.
“We will repay anyone who pays too much because they’re on an emergency tax code and individuals can claim a repayment earlier if they wish.”
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