Victory Claimed on Overtaxed Pensions, We Suggest Massive Failure

HMRC has announced that it is to overhaul the pensions in payment system, for flexible access drawdown where people draw down unlimited regular or lump sums amounts from their pension pot and end up on emergency tax.

Pensions Freedom started in April 2015 whereby all pensioners could access as much or as little as they want from their pension fund from age 55 (increasing to 57 in 2028). 

Flexi-Access Drawdown

This is now called ‘flexi-access drawdown’ and before April 2015, it was called ‘flexible drawdown’ only people with secure/guaranteed income e.g. annuities and state pension income above the following Minimum Income Requirement (MIR) limits could access ‘unrestricted’ flexible drawdown.

• Before 27 March 2014 = £20,000 pa MIR
• From 27 March 2014 to 5 April 2015 = £12,000 pa MIR.

Capped Drawdown

If you were below the above MIR limits, you could only access ‘capped drawdown’, whereby the maximum ‘drawdown’ was capped at 150% of the annuity rate your pension fund could by and set by the Government Actuary's Department (GAD).

Capped Drawdown before April 2011 was also known as unsecured pension income set at 0% and 120% of the single life annuity rate per annum before age 75 and after age 75 known as alternatively secured pension set 65% and 90% of the single life annuity rate.

Tax Code Headaches

It has been a long-standing problem that when people flexibly access their pensions, HMRC may not even know about it and so any first payments made by pension companies to clients must have Emergency Tax (week 1, month) applied.  This means that if you start drawing £2,000 pm, the pension provider must assume you have a zero tax code and deduct tax as if you are withdrawing £24,000 pa and all taxed at Basic Rate Tax 20% even if part of your pension income at the time would fall into your Personal Tax Allowance (£12,570 pa) and would have been free of income tax.  The pension provider must wait for HMRC to issue them with a tax code for your pension and then make the correct deductions of income.  It also then involves you making a tax reclaim for any over paid tax.

The position is made worse for ad-hoc withdrawals e.g. you may a ‘one off’ flex-access drawdown of £30,000.  Your pension provider must assume you are withdrawing £30,000 per month i.e., £360,000 and therefore, under emergency tax, tax most of your £30,000 at 40% and 45% and a small amount at 20%.  This resulted in many making a massive over payment of income tax and then having to reclaim it.

Admin Burden for HMRC – 9 Month Backlog

Since Pension Freedoms started in 2015, it has been estimated that 470,000 claims have been for over paid tax for refunds of around £1.37bn.  This was clearly an ill-thought-out solution that has created a massive administration burden on HMRC, not withstanding the hundreds of thousands of people that have been overtaxed and had to wait, sometimes for up to 9 months (that is HMRC’s current published turnaround time), for tax refunds.

HMRC Fix

HMRC has announced that from April 2025 it will move much quicker with a new system to issue tax codes to pension schemes (and remove emergency tax) for regular withdrawals meaning that pension companies will be able to administer regular pension fund withdrawals much better and at the correct tax rate.

Comment

This is only 'half a fix'.  It is welcome, but we suggest it will not help ad-hoc lump sum withdrawal taxpayers at all.  The system should be developed between providers and HMRC for pension providers to request a Tax Code on your behalf as part of your flexi-access drawdown application (regular or ad-hoc lump sum) and then issue a code immediately.

Our ‘temporary’ solution would be for flexi-access policyholders to:

• Set up a small regular withdrawal first e.g. if you need £36,000 ad-hoc lump sum, start off with £1,000 pm so minimal tax is deducted. 
• If HMRC keeps its promise, a tax code should automatically be issued quickly to you and your pension provider.
• You then stop all regular withdrawals and take the balance e.g. £35,000 of the ad-hoc lump sum required that would then have the correct tax code applied.