I read recently about people being overtaxed on pension withdrawals and think I might have some money to claim back from a drawdown payment made in July. How do I get my money back?

Paul

Tom Selby, AJ Bell Senior Analyst says:

Unfortunately you are not alone. According to the latest HMRC data some £27 million was repaid to overtaxed savers between April and July 2020, equating to £3,560 per claim – a record high.

The total amount reclaimed by people overtaxed on pension withdrawals has now reached £627 million since April 2015.

This overtaxation occurs because when someone accesses their retirement pot ‘flexibly’ for the first time in a tax year, HMRC applies an emergency ‘Month 1’ tax code to the withdrawal. Flexibly accessing your pension includes taking income via drawdown or withdrawing ad-hoc lump sums.

HMRC’s insistence on using a Month 1 tax code means your usual tax allowances will be divided by 12 and then applied to your withdrawal. It’s probably easiest to show how this works with a quick example.

Take someone who has no other taxable income and takes a £5,000 taxable withdrawal from their pension. Given the personal allowance for 2020/21 is £12,500, they might expect to pay 0% tax on the withdrawal.

However, because a Month 1 tax code is used this allowance is divided by 12 and then applied to the withdrawal (meaning only the first £1,042 will be taxed at 0%).

The basic-rate tax band of £37,500 is then also divided by 12 (giving a band of £3,125) and this part of the withdrawal is taxed at 20%. Finally, the remaining £833 will be taxed at 40%.

The net result is that, rather than paying £0 in tax, they will initially pay around £958.

GETTING THE MONEY BACK

If you are taking a steady stream of income via drawdown then you shouldn’t need to take any action, as HMRC will adjust your tax code to ensure that over the course of the year you are taxed the correct amount.

However, if you make a single withdrawal then you will either need to take action by filling out one of three forms, or rely on HMRC putting you in the correct position at the end of the tax year.

Which form you need to fill out will depend on how you have accessed your retirement pot:

If you’ve emptied your pot by flexibly accessing your pension and are still working or receiving benefits, you should fill out form P53Z;

If you’ve emptied your pot by flexibly accessing your pension and aren’t working or receiving benefits, you should fill out form P50Z;

If you’ve only flexibly accessed part of your pension pot then use form P55.

Provided you fill out the correct form HMRC says you should receive a refund of any overpaid tax 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 information 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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