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.<\/p>
In fact, since 2015 it\u2019s estimated that HM Revenue and Customs (HMRC) has refunded more than \u00a3800 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.<\/p>
It\u2019s 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\u2019ll pay depends on how much you withdraw in a tax year and how much income you have from other sources.<\/p>
Every year, you\u2019ll receive a personal allowance on which you pay no income tax at all. This is \u00a312,570 for the 2024-2025 tax year. If you receive more than this from your pension and any employment income combined, you\u2019ll pay at least 20% basic-rate tax. This rises to a higher rate of 40% for income over \u00a350,270 and up to \u00a3125,140, and 45% above this. These income tax thresholds apply in England, Wales and Northern Ireland. The thresholds and rates are slightly different in Scotland<\/a>, but the same principle applies.<\/p> 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 \u00a312,000, for example, you might incorrectly be charged up to 40% tax on some of your income. For an income of \u00a312,000, you shouldn\u2019t be charged any tax as this income falls within your personal allowance.<\/p> Pension tax overpayments commonly happen when you first take taxable income from a defined contribution pension<\/a>. 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.<\/p> 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\u2019s commonly known as a \u201cmonth 1\u201d tax code.<\/p> For example, let\u2019s 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 \u00a312,000 from your pension (having already taken your tax-free lump sum). \u00a312,000 is less than the annual personal allowance so, in theory, you shouldn\u2019t take any tax at all.<\/p> If you withdraw an even \u00a31,000 each month, this shouldn\u2019t cause any problems. The emergency tax code will correctly assume a total annual income of \u00a312,000 based on the first month of income in April.<\/p> 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.<\/p> So, rather than withdrawing an equal \u00a31,000 each month, you might decide to take out the full \u00a312,000 in month 1.<\/p> Based on the emergency \u201cmonth 1\u201d tax code, HMRC will assume that you\u2019ll withdraw \u00a312,000 every month. This would add up to an assumed total of \u00a3144,000.<\/p> This will mean you\u2019re over-taxed at the higher-rate 40% tax rate for some of your \u00a312,000 withdrawal. Plus, you lose all of your annual tax-free personal allowance if you earn more than \u00a3125,000. So, you risk incorrectly paying tax on all of your income rather than just the amount above your personal allowance.<\/p> This could mean you overpay by thousands of pounds in some cases and initially have less money in your pocket than you expected. You\u2019ll get it back eventually, but unless you proactively take corrective action, any tax overpayment probably won\u2019t be repaid until the end of the tax year.<\/p> If you\u2019ve received a pension advice slip, this should state your tax code on it. If it ends in \u201cM1\u201d (short for month 1), you\u2019ve been placed on an emergency tax code and risk overpaying tax. If in doubt, contact your pension provider or HMRC directly to ask.<\/p> Panic not. If you\u2019ve overpaid pension tax in the first year, you\u2019ll 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\u2019s done its calculations based on your total year\u2019s withdrawals. Of course, this may not do much to assuage your frustration if you\u2019ve had to get by on less take-home income than you were due.<\/p> However, there are steps you can take to claim your money back more promptly.<\/p> If you realise you\u2019ve overpaid pension tax and (understandably) don\u2019t want to wait until the end of the tax year to get it back, you should be able to claim it back sooner.<\/p> If you\u2019re 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\u2019t receive a P800, call HMRC to ask it directly.<\/p> If you\u2019ve overpaid on a lump sum withdrawal and are not receiving a regular income from your pension, you\u2019ll need to fill in a form on the government\u2019s tax refund website<\/a>.<\/p> You\u2019ll need to complete 1 of 3 forms depending on your circumstances. You\u2019ll be guided to the right form by the government\u2019s step-by-step process. Here\u2019s a summary:<\/p> You should receive a refund of overpaid tax within 30 days of submitting the form. If you don\u2019t want to use the government\u2019s online service, you can print out a paper version of the form to complete and post to HMRC.<\/p>What is overpaid pension tax?<\/h3>
Why might I overpay on my pension tax?<\/h3>
Why taking a flexible pension income can risk tax overpayment<\/h4>
How do I know if I\u2019ve been affected?<\/h3>
Will I get the pension tax overpayment back?<\/h3>
How do I reclaim overpaid tax on my pension?<\/h3>