The pension freedoms introduced in 2015 have given pension savers much more flexibility over how to access their pensions. But the ability to withdraw money flexibly, rather than taking a regular income, has also made it trickier to ensure that pension withdrawals are taxed correctly.
In fact, since 2015 it’s estimated that HM Revenue and Customs (HMRC) has refunded more than £800 million in overpaid pension tax. The risk of overpaying pension tax is highest when you make your first taxable withdrawal. This guide outlines why and how you can reclaim overpaid pension tax.
What is pension tax?
It’s the tax that you pay on money you withdraw from your pension above and beyond your 25% tax-free lump sum. In principle, it works in exactly the same way as income tax on employment earnings. The amount of pension income tax you’ll pay depends on how much you withdraw in a tax year and how much income you have from other sources.
Every year, you’ll receive a personal allowance on which you pay no income tax at all. This is £12,570 for the 2022–2023 tax year. If you receive more than this from your pension and any employment income combined, you’ll pay at least 20% basic-rate tax. This rises to a higher rate of 40% for income over £50,270 and up to £150,000, and 45% above this. These income tax thresholds apply in England, Wales and Northern Ireland. The thresholds and rates are slightly different in Scotland, but the same principle applies.
What is overpaid pension tax?
Overpaid pension tax is when you pay more tax than is warranted for the total income you receive in a tax year. So, even if you only receive a total annual taxable income of £12,000, for example, you might incorrectly be charged up to 40% tax on some of your income. For an income of £12,000, you shouldn’t be charged any tax as this income falls within your personal allowance.
Why might I overpay on my pension tax?
Pension tax overpayments commonly happen when you first take taxable income from a defined contribution pension. Taxable income is anything in excess of your 25% tax-free lump sum. Your pension provider is responsible for collecting the income tax due on money you withdraw from your pension before you receive any payments. But, when you first take money out, your pension provider might not yet know which tax code they should be using or details of any other income you might be receiving.
Until this information is confirmed by HMRC, the provider will have to deduct income tax using an emergency tax code. This is calculated on the basis of your taxable pension income in the first month. It’s commonly known as a “month 1” tax code.
For example, let’s say that you live in England, retire at the end of March and will no longer receive any employment income. Over the next tax year, you plan to withdraw a total of £12,000 from your pension (having already taken your tax-free lump sum). £12,000 is less than the annual personal allowance so, in theory, you shouldn’t take any tax at all.
If you withdraw an even £1,000 each month, this shouldn’t cause any problems. The emergency tax code will correctly assume a total annual income of £12,000 based on the first month of income in April.
Why taking a flexible pension income can risk tax overpayment
The problem is that your first withdrawal might be much higher than the withdrawals you make in subsequent months. It might even be the only withdrawal you make in that tax year. Following the relaxation of defined contribution pension withdrawal rules in 2015, you no longer need to buy an annuity with your pot and receive a consistent income. Instead, you can choose to withdraw as much as you need, whenever you need it.
So, rather than withdrawing an equal £1,000 each month, you might decide to take out the full £12,000 in month 1.
Based on the emergency “month 1” tax code, HMRC will assume that you’ll withdraw £12,000 every month. This would add up to an assumed total of £144,000.
This will mean you’re over-taxed at the higher-rate 40% tax rate for some of your £12,000 withdrawal. Plus, you lose all of your annual tax-free personal allowance if you earn more than £125,000. So, you risk incorrectly paying tax on all of your income rather than just the amount above your personal allowance.
This could mean you overpay by thousands of pounds in some cases and initially have less money in your pocket than you expected. You’ll get it back eventually, but unless you proactively take corrective action, any tax overpayment probably won’t be repaid until the end of the tax year.
How do I know if I’ve been affected?
If you’ve received a pension advice slip, this should state your tax code on it. If it ends in “M1” (short for month 1), you’ve been placed on an emergency tax code and risk overpaying tax. If in doubt, contact your pension provider or HMRC directly to ask.
Will I get the pension tax overpayment back?
Panic not. If you’ve overpaid pension tax in the first year, you’ll definitely get it back. The worst-case scenario is that HMRC repays the tax automatically at the end of the initial tax year once it’s done its calculations based on your total year’s withdrawals. Of course, this may not do much to assuage your frustration if you’ve had to get by on less take-home income than you were due.
However, there are steps you can take to claim your money back more promptly.
How do I reclaim overpaid tax on my pension?
If you realise you’ve overpaid pension tax and (understandably) don’t want to wait until the end of the tax year to get it back, you should be able to claim it back sooner.
If you’re drawing a regular income from your pension, in some cases your pension provider may realise the error and pay you back automatically. If not, HMRC should post you a P800 tax calculation, usually by the end of September. This will allow you to claim the refund either online or by cheque. If you don’t receive a P800, call HMRC to ask it directly.
If you’ve overpaid on a lump sum withdrawal and are not receiving a regular income from your pension, you’ll need to fill in a form on the government’s tax refund website.
You’ll need to complete 1 of 3 forms depending on your circumstances. You’ll be guided to the right form by the government’s step-by-step process. Here’s a summary:
Form P50Z applies if you’ve fully emptied your pension pot and received no other taxable income in the year.
Form P53Z applies if you’ve fully emptied your pension pot and have also received other taxable income in the year.
Form P55 applies if you haven’t fully emptied your pension pot.
You should receive a refund of overpaid tax within 30 days of submitting the form. If you don’t want to use the government’s online service, you can print out a paper version of the form to complete and post to HMRC.
How can I avoid overpaying pension tax in the first place?
Unfortunately, there’s not much you can do to avoid being put on an emergency tax code and charged the incorrect amount of tax. But there are a few things you can do to keep the impact to a minimum, including:
Make your first pension withdrawal a small one. Remember that your tax liability will be calculated based on an emergency code, which assumes you’ll withdraw the same amount that you withdraw in month 1 every month thereafter. If you take out a twelfth of your total planned pension income for the year as your first withdrawal, this should mean you’re taxed at the right level, even if you’re on an emergency code. You should then be free to take out a bigger amount in the second month if you wish. Keep an eye on the tax you pay to be sure, though.
If you need to make a bigger initial withdrawal, complete the correct tax-reclaim form at the same time as you take the money out. This will minimise the time between overpaying tax on that withdrawal and getting the overpaid tax back. This might be important if, for example, you have taken out the exact amount you need (assuming the correct amount of tax is taken) to cover something specific, such as paying off your mortgage or the holiday of a lifetime.
How can I find out how much tax I should be paying?
The government has an income tax calculator that lets you estimate how much income tax you should be paying on a given amount of income. It doesn’t differentiate between pension and employment income. You’ll need to add these together to work out your total tax liability.
Here are a couple of examples of how much tax you should be paying based on making a single taxable pension withdrawal in a tax year. We’ve also shown how much you could risk overpaying if you’re placed on a month 1 emergency tax code. These calculations assume no other income.
Pension withdrawal amount
Tax you should pay
Tax you might pay via emergency tax code
£5,000.00
£0.00
£952.37
£15,000.00
£484.20
£5,024.95
£30,000.00
£3,484.20
£11,774.95
Bottom line
Tax may be a necessary evil, but nobody wants to pay more than they need to, even in the short term. You’re unlikely to avoid being put on an emergency tax code when you first take taxable income from your pension. While you’ll get any overpaid pension tax back eventually, there are tactics you can employ to minimise the risk of overpaying in the first place and getting back overpayments quickly if you do.
Frequently asked questions
If you think you’ve overpaid pension tax, let HMRC know as soon as possible by filling in a tax refund form. The specific form you need to complete depends on your personal circumstances and the type of withdrawal you’ve made. You can access the right form online via the government’s tax refund service.
If you fill in a tax refund claim form, you should get the money back within 30 days. Otherwise, you’ll get it back automatically at the end of the tax year in which you overpaid tax.
The pension lifetime allowance is the maximum you can build up in a pension fund having benefited from tax relief on contributions. If you exceed this maximum – currently frozen at £0 until the 2025–2026 tax year – you’ll face a tax charge on top of any income tax due. The pension lifetime allowance tax charge will typically apply when you start taking money out of your pension pot.
From the age of 55, you are entitled to take 25% of the total value of your pension without paying tax on it. This is often referred to as the pension tax-free lump sum. It’s tax-free regardless of any other income you might receive. You can either take your tax-free amount as a one-off withdrawal, or receive 25% of multiple smaller withdrawals tax-free if you leave your pension pot invested (or “uncrystallised”) rather than buying an annuity or moving it into a drawdown scheme.
Finder survey: Would you ever stop paying into your workplace pension to use the money for something else?
Response
No
49.42%
I don't have a workplace pension
26.55%
Yes
24.03%
Source: Finder survey by Censuswide of Brits, December 2023
Ceri Stanaway is a researcher, writer and editor with more than 15 years’ experience, including a long stint at independent publisher Which?. She’s helped people find the best products and services, and avoid the pitfalls, across topics ranging from broadband to insurance. Outside of work, you can often find her sampling the fares in local cafes.
Use our simple guide to understand how much state pension to expect, how it’s calculated and if you can boost it.
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