If you’re looking to make the most out of the pension freedoms, managing withdrawals so you pay as little tax as possible is absolutely critical.

A quarter of your pension pot can usually be withdrawn tax-free, with the remaining 75% taxed in the same way as income.

This should be the case whether you buy a guaranteed income stream (an annuity), keep your money invested and draw a regular income (drawdown), or take an ad-hoc ‘uncrystallised funds lump sum’ (UFPLS).

Health warning

The UFPLS option comes with a health warning. If you’re planning to make a single UFPLS withdrawal from your fund you risk being hit with a hefty ‘emergency’ tax bill from HM Revenue & Customs (HMRC).

Rather than treating this as a single payment, the taxman assumes you are going to keep taking money out of your fund for the rest of the year.

Take someone who makes a UFPLS withdrawal of £10,000 in April – the start of the tax year – and has no other income. Given that the personal allowance is currently £11,500, they would understandably expect to pay no tax on the money.

Because an emergency tax code is applied, HMRC divides the personal allowance by 12, meaning only £958.33 of the withdrawal is tax-free. The next £2,791.67 (£33,500 divided by 12) is taxed at 20%, with the remaining £6,250 taxed at 40%. After all that, our saver gets back £6,941 – which is £3,059 less than they expected.

Getting your money back

If you have been overtaxed on your pension, you need to fill out one of three forms:

1. P53Z: If you have cashed in your entire pension and have one or more other sources of income

2. P50Z: If you have cashed in your entire pension and have no other sources of income

3. P55: If you have cashed in part of your pension and don’t intend to make any further withdrawals

Once you’ve sent off the form you should get your money back within 30 days.

According to HMRC, a whopping £262m has been repaid to savers who have been overtaxed since the pension freedoms launched.

However, this is probably the tip of the iceberg because it only covers those who have completed the official forms.

While 107,000 of these forms have been sent to HMRC since April 2015, we reckon somewhere in the region of half a million withdrawals that risk being overtaxed were made during that period. That leaves hundreds of thousands of savers who have done nothing to get their cash back.

Clearly relying on the efficiency of HMRC to sort out your finances isn’t a great strategy, so the only way to guarantee you aren’t short-changed is to sort it yourself by filling out the correct tax reclaim form.

Tom Selby, senior analyst,
AJ Bell

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