Pensioners overtaxed by more than £3,000 each after ‘indefensible’ HMRC errors
The taxman overcharged pensioners a record £200m last year because of “indefensible” quirks in the tax system left unfixed for a decade.
HM Revenue & Customs (HMRC) has been forced to hand back more than £1.2bn to hundreds of thousands of pensioners since 2015, when pension freedom reforms took effect, after they fell victim to “emergency pension tax” that are leaving them overtaxed to the tune of £3,000 a head on average.
The reforms give retirees more flexibility on how to use their pension funds, including taking out lump sums or buying an annuity.
When retirees first withdraw money from a typical “defined contribution” pension, they are taxed by HMRC.
However, instead of using the saver’s normal income tax rate, HMRC opts for a higher emergency rate.
The taxman assumes that a one-off withdrawal will be replicated every month, so someone taking £10,000 will be taxed on it as if they were taking £120,000 over a year.
This has meant pensioners being hit with shock bills running into the thousands of pounds. HMRC was forced to reimburse pensioners over £198m in the 2023-24 tax year.
In the last three months alone, the taxman handed back £42m, HMRC figures show. It processed 13,261 reclaim forms over this period, for an average refund of £3,167.
Sir Steve Webb, a former pensions minister, now of consultants LCP, said: “This farce has been going on for nearly a decade where the system is run for the convenience of HMRC, not taxpayers.
“Every year, tens of thousands of retirees are routinely overtaxed and have to jump through hoops to get their own money back.
“Shockingly, over £1bn has had to be claimed back. It’s indefensible.”
While HMRC says all overpayments will eventually be refunded, this may not be until the end of the tax year, squeezing the incomes of those who have been overcharged. Overpayments can be claimed back sooner, but taxpayers must manually apply.
Tom Selby, of AJ Bell, said: “A decade on from former chancellor George Osborne’s bombshell pension freedoms announcement at the March 2014 budget and the tax system which governs flexible retirement withdrawals remains faulty.
“Depressingly, the true overtaxation number will likely be substantially higher. In particular, people on lower incomes who are less familiar with the self-assessment process might be less likely to go through the official process of reclaiming the money they are owed. As a result, they will be reliant on HMRC putting their affairs in order.
“It is simply unacceptable that the Government has failed to adapt the tax system to cope with the fact Britons are able to access their pensions flexibly from age 55, instead persisting with an arcane approach which hits people with an unfair tax bill, often running into thousands of pounds.
An HMRC spokesman said: “Nobody overpays tax as a result of taking advantage of pension flexibility.
“We will automatically repay anyone who pays too much because they’re on an emergency tax code. Individuals can claim back any overpayment earlier if they wish.”
