Convoluted tax system means many savers are wrongly hammered by HMRC when accessing pension cash.
The total amount HMRC has been forced to repay savers who were wrongly taxed when accessing their pension funds has almost doubled in the last year, new figures show.
Between July and September 2022, the taxman returned a total of £33.1 million to overtaxed savers.
However, official figures released by the Government show this figure jumped to £61.3 million during the same three-month period of 2023, with the average tax refund worth £3,252.
Read: how to avoid the pension withdrawal emergency tax
How pension savers get wrongly taxed
Being able to tap into our pension funds as we 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 cost of living crisis.
It means savers have been able to boost their own incomes, 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 to 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In effect, the lump sum you take out is treated as if that sum will be withdrawn every month, with the knock-on effect that would have on your overall income for the year.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.
Total tax bill likely far higher
The £61.3 million refunded in the last quarter is an astonishing amount of money at the best of times, let alone in the middle of a cost-of-living crisis that shows little sign of ending.
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 £61 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.
Savers have reclaimed more than £1 billion in overtaxation on pension withdrawals since 2015, according to analysis by financial firm AJ Bell.
Read: how to avoid the pension withdrawal emergency tax
loveMONEY comment: it doesn’t have to be like this
It would be somewhat understandable, perhaps even excusable if this was a new situation.
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.
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.