Pension flexibility: too taxing for many

Recent HMRC statistics highlight the over-taxation of some pension benefits.

More than one million people have received flexible pension payments thanks to therules introduced just over four years ago. HMRC’s most recent statistics, to the end of March 2019, show that 1,113,000 people have withdrawn over £25,600m from their pensions, across 6,136,000 payments. The amounts withdrawn and the number of payments have both increased each tax year – in 2018/19 there were over 2,400,000 payments totalling £8,180m.

However, the system is causing some problems for HMRC. In the first quarter of 2019 HMRC refunded £31.1m of overpaid tax to over 12,500 people who had used pension flexibility. The over-collection is a result of HMRC’s insistence on using emergency tax codes where a pension provider does not have a current tax code for the individual, which is usually the case on a first withdrawal. More often than not, emergency tax codes create too high a tax deduction, as the example shows.

Emergency, Emergency!

Graham, who lives in England, expects to have an income of about £28,000 in 2019/20. He decided to draw £24,000 from his pension plan as an uncrystallised funds pension lump sum (UFPLS). He knew that a quarter of this would be tax free, with the £18,000 balance taxable. As that would still leave him comfortably below the £50,000 higher rate threshold, he expected to receive £20,400 as a net lump sum (£24,000 – £18,000 @20%).

In fact, he received £17,619 because an emergency tax code was applied to the taxable element of his UFPLS.

The excess tax can be reclaimed and HMRC has created dedicated forms to speed up the repayment process. In theory if no reclaim is made, the tax should eventually be refunded once HMRC undertakes its end of year reconciliation – but that could mean waiting over 12 months if the payment is taken early in the tax year.

If you are thinking about using pension flexibility, it pays to take advice before asking for the payment. In some circumstances the emergency code issue can be sidestepped, but if it cannot, then you need to be aware of what you will receive initially and the process of tax reclaim.

The value of your investment can go down as well as up and you may not get back the full amount you invested.

Past performance is not a reliable indicator of future performance. Investing in shares should be regarded as a long-term investment and should fit in with your overall attitude to risk and financial circumstances.

The value of tax reliefs depends on your individual circumstances. Tax laws can change. The Financial Conduct Authority does not regulate tax advice.

13th June 2019