Convoluted tax system means many savers are wrongly hammered by HMRC when accessing pension cash.
Pension savers are becoming more confident about dipping into their pension pots through the pension freedoms, new figures suggest.
The latest data from HM Revenue & Customs (HMRC) shows that a total of £2.4 billion was withdrawn from pensions flexibly in the final quarter of last year, up from £2.2 billion in the same period of 2019.
This is reflected in the numbers of savers pulling money from their pension pots, which jumped from 327,000 to 360,000 year-on-year.
Being able to tap into those pension funds as you see fit has been one of the big selling points of the pension freedoms, and that facility has likely been even more valuable given the incredible uncertainty caused by Covid-19.
It means savers have been able to boost their own incomes, perhaps as they have been placed on furlough, or even offer some financial support to loved ones who are in a more precarious position with their money.
However, there remains a significant downside with the pension freedoms ‒ the potential for being overcharged tax when making withdrawals.
It all comes down to the way that HMRC handles certain withdrawals, where the tax is calculated using a higher-rate emergency tax code.
In effect, the lump sum you take out is treated as if that sum will be withdrawn every month, with the knock-on effect that would have on your overall income for the year.
So if you took out £5,000, it would be taxed as if you were going to be withdrawing £60,000 for the year.
That would mean your income is treated as if you are in the higher Income Tax band, when the reality may be that for the year you bring in less than the £12,500 personal allowance, which should mean you pay no tax at all.
The sheer sums involved in these tax overpayments are mind-boggling.
According to the latest data, the taxman handed back just shy of £26 million in overpaid tax in the last quarter of last year to people who had flexibly accessed their pension cash and been overtaxed as a result.
That’s an astonishing amount of money at the best of times, let alone in the middle of a global pandemic when we know full well that there is economic nastiness ahead.
It’s worth remembering that these are just the people who opted to put in a claim for tax overpayments now ‒ there will be many more who do so at the end of the tax year.
What’s more, there will be some who are simply unaware that they have been overtaxed and so don’t actually make a claim.
In other words, this £26 million in repaid tax is most likely just a fraction of the overall amounts that have wrongly ended up in the taxman’s coffers.
What’s more, the money repaid quickly adds up. Analysis from AJ Bell suggests that since the introduction of the pension freedoms, the taxman has had to hand back a frankly farcical £693 million. Any way that you look at it, that’s ridiculous.
It doesn’t have to be like this
If the pension freedoms had only just been introduced and this was an unexpected result, with promises from the authorities to clear up the confusion and ensure that we don’t end up with this taxation hokey cokey where you put the tax in, then claim to take the tax back.
But that isn’t where we are.
The pension freedoms have been with us for years now, and yet the tax authorities carry on regardless.
Helen Morrissey, pension specialist at Royal London, put it best when she said that it was “absurd” that this overly complex system remains in place, years after the introduction of the freedoms.
She added: “HMRC overtaxes people who then need to fill out any one of three different forms to reclaim this money back.
In the last quarter, we saw a rise in the number of people looking to access their pensions flexibly – this may well be due to the current COVID-19 pandemic.
The last thing they need at such a difficult time is to be over-taxed and then have to reclaim it – it is a system in urgent need of reform.”
We can’t simply wave this off any more.
The Government and the taxman need to crack on with reforming the process so that we don’t end up with such significant sums wrongly ending up in the taxman’s hands.
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