Pension Freedom Leads To Over-Taxation

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November 29th 2021
Tax Week 34
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Pension Freedom Leads To Over-Taxation

Some people withdrawing money from pension pots are being taxed too much.

George Osborne introduced the ability for people over-55 years of age to access their private pension 'accounts' whenever they wish and make withdrawals. This was in contrast to the long tradition of taking a certain amount tax-free and the mandatory rule for the remainder to be invested by purchasing an annuity.

The reforms allowed people to take a payment from the pension pots anytime but can lead to taxation problems. The UFPLS (Uncrystallised Fund Pension Lump Sum) lets individuals take smaller chunks of money from the pot and up to 25% of the pot amount in withdrawals is untaxed. The remainder of withdrawals however, are subject to income tax.

HMRC taxes the withdrawals in a cumulative manner like PAYE and therefore some people who have not had an adjusted tax code delivered to their pension provider are taxed using emergency tax.

The emergency tax scenario leads to the amount withdrawn being extrapolated into an annual income and the tax charged based upon that amount - even though the withdrawal will very likely be a one-off. So, in cases where the personal allowance is £11,500 and someone withdraws £11,500 and has no other income - they still get taxed as if they would be earning £138,000 in that tax year.

In practice HMRC are meant to send a tax calculation to individuals at the end of the tax year to make sure that the tax deducted matches the amount of income earned/withdrawn in the tax year. It appears however that those withdrawing are having to file tax returns in order to rectify the mistakes and get refunds for overpayments.

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