Over 800,000 people who opted to withdraw lump sums from their pensions could have been charged far too much tax if they were given the wrong tax code.
According to pension firm Royal London, many people under the State Pension age who are receiving pension income should be classed as non-taxpayers if their total income is below the Personal Allowance threshold.
This could be a bigger issue for those who have multiple sources of taxable income – people with multiple pensions and a wage, for example, are likely to be losing more money.
What's worrying is that some people in this situation may have been subject to overtaxing for years.
The problem is that, when you withdraw a lump sum from your pension for the first time, it will automatically be taxed through the PAYE system.
And because the system doesn’t know your tax code, it assumes your lump sum is actually your monthly income and taxes you accordingly.
Research from investment firm AJ Bell suggests that hundreds of thousands of people are paying more for their pension than they should because they're not claiming tax refunds.
The investment company found that only 11,000 refunds per quarter have been paid out since 2015 compared to the average 139,000 pension pots being accessed every three months during this period.
Do you think you might be overpaying? Read on to find out how to check you're on the right tax code and how to claim a refund.
Knowing your tax code
Royal London is urging people to check their tax code to make sure they’re not being overtaxed.
There are several different tax codes which are dependent on your income. But if your code is wrong, it’s crucial that you contact HMRC.
You’ll need to have your tax reference and National Insurance number on you. They can be found on your payslips or on any letters from the taxman.
Don't worry, tax codes are notoriously complicated. Founder of the charity Tax Help for Older People, Paddy Millard MBE, agrees: “Tax codes are probably one of the biggest single causes of confusion and problems amongst the people who contact us via our helpline.
"People should not simply assume that HMRC have got things right, but should check to make sure that they are paying the right amount of tax.”
Any income you take is taxed under Income Tax rates, so for the 2017/18 tax year, you pay:
- No tax if your total income is below £11,500;
- 20% if your total income is between £11,501 and £45,000;
- 40% if your income is between £45,001 and £150,000;
- 45% if your total income exceeds £150,000.
If this is the first time that you’re dealing with your pension provider, they probably won’t know your tax code, nor will they know how much income you have from other sources.
That means you'll be taxed on a ‘Month 1’ basis, so you’ll be taxed as though the lump sum you’re drawing is being repeated every month.
Claim that refund
You'll need one of three forms to claim a refund, depending on your circumstances:
- P50Z is for people who have stopped working and have taken their entire retirement pot;
- P53Z is for those who have taken their entire pot but are still working;
- P55 is for those who withdraw part of their pension pot as a lump sum, but not the whole lot.
All three of these can be found on the government website.
Overpayments will eventually be repaid by HMRC if you don't do anything, but you could be hanging around for quite some time. However, if you actively claim a refund it should take no longer than four weeks to recover your cash.