The 2015 pension reforms introduced significant changes that allowed individuals to access their pension funds in a more flexible manner. One aspect of these reforms, however, led to a widespread issue where many pensioners were over-charged on tax by HM Revenue & Customs (HMRC). The problem stemmed from the application of emergency tax codes to pension withdrawals, which often resulted in the incorrect calculation of tax deductions.
Prior to 2015, pensioners were largely required to purchase an annuity upon retirement, leaving them with limited flexibility in managing their pension funds. However, with the introduction of pension freedoms, individuals over 55 could choose to access their pension in various ways, including withdrawing money in small amounts or receiving a lump sum. This newfound flexibility led to a significant number of pensioners taking advantage of these options, but unfortunately, many were subject to incorrect tax calculations due to the emergency tax code rule.
When pensioners withdrew additional amounts from their pension funds, HMRC often assumed that this was the start of a series of regular payments throughout the tax year. Consequently, they deducted extra tax, which resulted in overpaid tax for many individuals. To rectify this situation, pensioners had to reclaim their overpaid tax, a process that was not only time-consuming but also caused undue stress.
Since the introduction of these new tax rules, HMRC has paid back approximately £1 billion in overpaid pension tax, a staggering amount that highlights the scale of the problem. The issue has been exacerbated by the fact that many pensioners were left in the dark, unaware that they had overpaid tax or how to recover their losses.
So, how can you determine whether you’re due a pension tax code refund? To qualify for a refund, you must be at least 55 years old (and will rise to 57 from 2028) and have taken a taxable lump sum from your pension for the first time, or withdrawn your entire pension pot in a single transaction. This refund is available whether you’ve taken a small amount or your entire pension, as long as it’s your first taxable withdrawal.
If you believe you’re entitled to a refund, you can take immediate action to claim it back. Even if you do not take any steps, HMRC should automatically refund the overpaid tax to you by the end of the tax year, which falls on 5 April. However, to receive the refund ahead of the new tax year, you’ll need to complete one of three different forms, depending on your individual circumstances.
If you’ve fully emptied your pension pot and have no other income in the tax year in question, you should use form P50Z. This form is specifically designed for individuals who have exhausted their pension fund and have no other sources of income to declare for tax purposes. Completing this form will allow you to claim a full refund of any overpaid tax.
If, however, you’ve fully emptied your pension but do have other taxable income during the same tax year, form P53Z is the correct form to use. This form is used when an individual has other sources of income, such as a salary or investments, in addition to the pension fund they’ve withdrawn. By using this form, you can accurately claim back any overpaid tax from your pension.
Finally, if you haven’t fully emptied your pension pot and are still drawing down on your pension income, use form P55. This form is designed for individuals who are still actively receiving regular pension payments and need to correct any tax errors that have led to overpaid tax.
It’s essential to be aware that the deadline for submitting these forms is the end of the tax year, and it’s advisable to act promptly to avoid missing out on any potential refund. As HMRC’s automatic refund process is designed to recover overpaid tax by the start of the new tax year, using these forms ahead of this deadline ensures that you receive the refund as quickly as possible.
In a step towards resolving this issue, HMRC has announced plans to replace emergency tax codes with regular ones from April 2025. This change will significantly reduce the likelihood of overpaid tax, as the new tax code system will be designed to calculate the correct amount of tax deducted in real-time. A newsletter issued by HMRC confirms that they will automatically update the tax code for individuals who are currently on a temporary tax code and would benefit from being on a cumulative code.
This change will benefit those who, for the first time, start to receive ongoing pension payments. According to the newsletter, there is no need for individuals to contact HMRC, as they will automatically update the tax code and inform affected parties by letter or digitally, if they’re signed up for paperless communication with the HMRC app or online services. This move is a significant step towards resolving the long-standing issue of overpaid pension tax and ensuring that individuals receive the correct amount of tax deductions.
In summary, the introduction of emergency tax codes in 2015 led to widespread issues with overpaid tax among pensioners. Since then, HMRC has paid back approximately £1 billion in overpaid pension tax, a testament to the scale of the problem. By understanding the rules surrounding pension tax and taking the necessary steps to claim a refund, individuals can recover any overpaid tax and ensure they receive the correct amount of tax deductions in the future. With HMRC’s commitment to introducing a new tax code system from 2025, the issue of overpaid tax is expected to be significantly reduced, providing greater peace of mind for those accessing their pension funds.