Too Much Tax Grabbed From Pension Savers

The tax filing deadline has just passed but tens of thousands of retirement savers who took money from their pensions under new easy access rules have probably paid too much, warn financial experts.

With more than 232,000 over 55s taking advantage of new pension freedoms, many will find they have paid more income tax than they should because of PAYE code errors.

HM Revenue and Customs (HMRC) provides the codes based on earnings and pension cash received in the previous tax year, but is not very good at the job, says accountancy firm Smith and Williamson.

Pension providers must apply the code to tax any pension cash withdrawal.

Low chance of paying the right tax

“Some people will have paid the right amount of tax, but the majority who took lump sums will probably have paid the wrong amount. The chance of HMRC getting it right is relatively low,” said the firm’s Tina Riches.

“The PAYE system doesn’t work particularly well when there is more than one source of income or where that income is taken in single sums.”

The experts say the problem arises mostly with one-off withdrawals as most pension payments prior to pension freedoms starting in April 2015 were monthly.

If the saver was a higher or additional rate taxpayer (40%/45%) in the previous year, but dropped down to the basic rate (20%) last year, they are likely taxed at the higher rate which is double what they should have paid.

PAYE codes lag incomes

The reverse is also a problem – someone paying basic rate tax who withdrew a pension payment that took them into the higher rate may find they had not paid anywhere near enough tax on their cash.

New retirees also face problems as their income in the previous year would be much higher.

Accountant Nimesh Shah, of Blick Rothenburg, said: “It’s a real issue. Pension companies didn’t know what marginal rate of tax someone should have paid.

“They were relying on information from HMRC, but often this wasn’t correct, because someone’s income could be very different one year to the next and the code had not caught up with the changes.”

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