A system which overtaxed hundreds of thousands of pensioners is set to be overhauled.
When pension freedoms were introduced in 2015, giving people more flexibility over their savings, people with defined contribution (DC) pensions were allowed to take their cash out in chunks rather than being forced to buy an income for life.
Since then, over 470,000 claims have been made for refunds totaling £1.37bn via the HMRC system.
However, HMRC chose to apply emergency tax codes to such withdrawals meaning that people often ended up paying far more tax than needed and then had to claim it back.
Now, the department has announced that it will move much more quickly to replace these emergency tax codes with regular ones which will make sure the correct amount of tax is deducted in real time.
This should drastically reduce the need either for end-year reconciliations or form-filling to claim back over-paid tax, particularly where people make multiple withdrawals in a single year.
Former pensions minister Sir Steve Webb said this was a “victory” for the many people who were impacted and had to “jump through hoops” to claim their own money back.
He said: “It is great news that at long last HMRC has listened to the voices of ordinary taxpayers and changed this scandalous system.
“This new system should mean that far more people are quickly moved on to the correct tax code and no longer end up with an overpayment of tax.
“The tax system is complex 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.”
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Read MoreHMRC buried the announcement in their latest Pension Schemes Newsletter, in an article called ‘helping customers get on the right pension pay faster’.
It read: “From April 2025, we are improving how tax code information is used for those people who are new to receiving a private pension, so they pay the right amount of tax from the outset.
“We will automatically update the tax code for customers who are on a temporary tax code and would benefit from being on a cumulative code – this means they’ll avoid an overpayment or underpayment at the end of the year.
“There is no need to contact HMRC and once a tax code has been changed, we’ll inform customers by letter or digitally if they’ve signed up for paperless in the HMRC app or online.”
Pensioners reclaimed £50m in over taxation on pension withdrawals in October, November and December, figures in the newsletter revealed.
Over 14,000 reclaim forms were processed during the quarter, with an average reclaim of £3,389.
Now, almost £1.4bn has been reclaimed by people overtaxed on pension withdrawals since 2015.
Tom Selby, director of public policy at AJ Bell, said these figures are likely only “the tip of the iceberg” because it only captures those who fill in the relevant HMRC reclaim form.
He said: “In reality lots of people, such as those on lower incomes who are less familiar with the self-assessment system, will not go through the official process of reclaiming the money they are owed. As a result, they will be reliant on HMRC putting their affairs in order.
“HMRC has offered a glimmer of hope to those who take a regular drawdown income [with the news it is improving its tax code process].
“But that doesn’t help those people taking ad-hoc lump sums from their drawdown pot and still means the first payment for all will be overtaxed.”
Mr Selby said it is “simply unacceptable” that the Government has failed to adapt the tax system to cope with the fact Britons are able to access their pensions flexibly from age 55.
One-way savers planning to take a single withdrawal in a tax year can potentially avoid the shock of a big over taxation bill is taking a notional withdrawal first, he said.
This should mean HMRC is able to apply the correct tax code to the second, larger withdrawal.
He added: “Alternatively, you can fill out one of three HMRC forms and you should receive your tax back within 30 days.
“If you don’t do this, the Revenue says it will put you back in the correct tax position at the end of the tax year.”
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