Pension freedom rules have given people earlier and more flexible access to their retirement savings. However, many are paying too much tax when they first make a withdrawal, due to the way HMRC’s computer systems operate.

Latest HMRC data shows it processed 12,000 reclaim forms in the last three months of 2023 relating specifically to this issue. In total it paid back nearly £39m to savers who have been overtaxed on pension withdrawals, making the average rebate £3,216.

The problem occurs when savers first make a withdrawal from a drawdown plan (rather than just taking their tax-free lump sum). HMRC software assumes that this payment will be a regular monthly withdrawal, and taxes it accordingly, via an emergency tax code.

Tax rebate

In many cases, however, people aren’t taking a regular payment but are using the pension freedom rules to make one or more ad-hoc withdrawals – perhaps to pay for a holiday, home improvements or reduce debts – and so end up with a smaller sum due to this taxation issue. If you have been overtaxed, you can claim this money back via an HMRC form. Complete either a P55, P53Z or P50Z depending on your circumstances. Those who don’t complete a form should have this tax readjusted in the following year, via the self-assessment process.

Staged payments

If you are planning to make a flexible withdrawal from your pension plan in the near future, there are steps you can take to try to avoid this problem. The best way is to make a very small initial withdrawal. The temporary tax code is then imposed on this smaller sum, and will be reapplied to the second, larger withdrawal. There may still be some adjustments to make but it is unlikely to result in such a large overpayment.