I’ve just taken £10,000 out of my SIPP (my first withdrawal) to pay for a new car. I expected a quarter of the withdrawal to be tax-free, with the rest taxed in the same way as income.

As a basic-rate taxpayer earning around £30,000 a year, I figured this would mean I’d pay £1,500 on the taxable part (i.e. 20% of £7,500).

You can imagine my shock when rather than receiving £8,500 as expected I was paid a lot less. Can you explain why this is and whether I’m owed any money?

Paula

By Tom Selby, AJ Bell Senior Analyst 

Unfortunately you’re one of a growing number of people who have fallen victim to HMRC’s pensions tax trap.

You are absolutely right that the taxable part of your withdrawal should have been taxed at 20% (assuming you have no other sources of taxable income beyond the £30,000 you mentioned).

However, because it was your first withdrawal HMRC will almost certainly have required your provider to  apply a ‘Month 1’ (or emergency) tax code to the taxable portion. This will have resulted in you being overtaxed in the first instance.

HOW ‘MONTH 1’ TAXATION WORKS

When a Month 1 tax code is applied, HMRC divides your usual allowances by 12 and then applies this to your taxable pension withdrawal. This will happen regardless of when the withdrawal is made or how much income you receive from other sources.

So in your case, rather than the entire £7,500 being taxed at 20% as you expected, three different rates will have been applied.

The first £1,041.67 of the withdrawal (1/12th of the £12,500 personal allowance) will have been taxed at 0%, while you’ll have paid 20% tax on the next £3,125 (1/12th of the £37,500 basic-rate tax band).

The rest of the withdrawal will have been taxed at the 40% rate, leaving you with a total tax bill of almost £1,958 – some £458 more than you should have paid.

GETTING YOUR MONEY BACK

The good news is it’s relatively straightforward to get your money back. You will just need to fill out one of the following three forms:

If the withdrawal used up your entire pension pot and you have no other income in the tax year, use form P50Z;

If the withdrawal used up your entire pension pot and you have other taxable income, use form P53Z;

If the withdrawal didn’t use up your pension pot and you’re not taking regular payments, use form P55.

You can find all the forms here: Once you’ve filled the form out and sent it off, HMRC says you’ll get a full refund within 30 days

DO YOU HAVE A QUESTION ON RETIREMENT ISSUES?

Send an email to editorial@sharesmagazine.co.uk with the words ‘Retirement question’ in the subject line. We’ll do our best to respond in a future edition of Shares.

Please note, we only provide guidance and we do not provide financial advice. If you’re unsure please consult a suitably qualified financial adviser. We cannot comment on individual investment portfolios.

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