Lisa Webster: Over-taxation of pensions remains an issue

HMRC’s January pension schemes newsletter announced changes to tax codes for pensions, and a few headlines followed proclaiming HMRC had finally fixed the over-taxation issue. It would be fantastic if that was the case, but despite nearly 10 years of getting it wrong, the problem isn’t resolved yet. The changes that were announced mean that from April, HMRC will automatically update the member’s tax code after the first payment has been made under PAYE, without the need for the scheme administrator to separately notify them. The automation of this process should mean the corrections for subsequent withdrawals in the tax year will be made more quickly. This is undoubtedly a step in the right direction, and this improvement will lead to a better outcome for some clients. However, it doesn’t change anything for those who are making one-off pension withdrawals – these will continue to be overtaxed. At the heart of the issue is the fact that HMRC insist on tax codes being applied to the first pension withdrawal on a “month 1 basis”. This is regardless of whether the member has an emergency tax code or has provided a current year P45. If regular payments are being made, the first payment is still overtaxed, but the new system will mean the tax position will get corrected quicker. The new code is applied to subsequent withdrawals in the tax year to put the member in the correct position. But if there are no subsequent payments, then nothing has changed. The way to fix the problem for members who only intend to make a single withdrawal in the tax year, would be for HMRC to allow schemes to apply the tax code on a “month 12” basis. This gives the full annual personal allowance and tax bands for the single payment, opposed to only a twelfth on the 'month 1' basis. Bizarrely, HMRC allow this for one off-payments under capped drawdown, but not for flexi-access drawdown or UFPLS payments. This issue is not insignificant. In the last quarter of 2024 alone over £49.5 million of overpaid tax was reclaimed from HMRC via 14,612 forms. When you consider over 6,000 of these were relating to pension payments that emptied the fund, so no possibility of further payments in the tax year, then applying a 'month 1' code seems particularly perverse. It also makes no difference when in the year the payment is made – if it was paid on 5 April the administrator still has to process it on the 'month 1' basis. Since the Pension Freedoms were introduced in April 2015, the total amount of overpaid tax reclaimed via forms is almost £1.4 billion. HMRC is meant to be on an efficiency drive. Allowing payments to be made on month 12 basis where the member has clearly stated it is the only withdrawal, would be an easy win to remove work from their desks. Lisa Webster is senior technical consultant at AJ Bell. She is an economics graduate with over 15 years’ experience in financial services. Prior to joining AJ Bell in May 2014 she spent nine years working in senior technical and consultancy roles at a major SIPP and SSAS provider. She is part of the AJ Bell Technical Team. Email: This email address is being protected from spambots. You need JavaScript enabled to view it. Twitter: @lisasippster

Lisa Webster: Over-taxation of pensions remains an issue

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