Beware of Emergency Tax When Drawing on Your Pension!

You could be hit by a heavier tax burden than you may have anticipated if you are over 55 and making an ad-hoc withdrawal from your pension. In ordinary circumstances those taking withdrawals should be taxed at the appropriate marginal rate.

When taking the first withdrawal in a tax year HMRC has instructed pension providers to apply an emergency tax code known as "Month 1". Due to this code, the withdrawal is compared against only 1/12th of the tax allowance, leading to over-taxation. The payment is treated as if it is the first of 12 monthly payments, despite the fact that it could have been intended as a single lump sum.

A single £2,000 withdrawal could lead to being overtaxed by £200, with a withdrawal of £10,000 potentially attracting over-taxation of £3,000.

HMRC does refund this money, however, claims can take up to a year. Tom Selby of Sipp provider AJ Bell says that:

"Tens of thousands of people using the pension freedoms every month risk falling into this tax trap. On average, the level of over-taxation runs into thousands of pounds and for some it could be tens of thousands of pounds.

The problem is at its most acute at the beginning of the tax year as anyone who makes an ad-hoc withdrawal and doesn’t fill out the right form to claim the money back will have to wait until at least April 2019 to get their money back. Even then, you are relying on the efficiency of HMRC to put you back in the position you should have been in in the first place."

Approximately 140,000 retirees access their pension for the first time every quarter, with a large proportion being taxed at the emergency rate according to HMRC. However, only a small proportion of these new retirees are claiming the emergency tax back, as HMRC is only processing approximately 10,500 forms per quarter, which is a massive disparity. This suggests that pensioners are either unaware that they have been overtaxed or are expecting HMRC to remedy the situation.

Tom Selby of AJ Bell says:

‘Savers accessing their pensions for the first time using the freedoms understandably expect to receive the correct amount of money. Many will have specific plans for their withdrawal, such as to pay down debt or fund long-term care for an elderly relative. For people like this, getting thousands of pounds too little will present a serious financial challenge.

‘HMRC should, at the very least, consult on its approach to single pension freedoms withdrawals and review the risks it poses to savers. Allowing providers to apply a ‘Month 12’ tax code would be a more consumer-focused solution, with HMRC taking responsibility for recouping any underpaid tax.’

Contact Westminster Wealth Management today and one of our skilled advisers can construct a financial plan for you that will enable you to meet your financial goals.

The value of investments and income from them may go down as well as up and you may not get back the original amount invested.

A pension is a long-term investment. The fund value may fluctuate and can go down. Your eventual income may depend upon the size of the fund at retirement, future interest rates and tax legislation.