Tax Attack - 400,000 have claimed back where they’ve been overtaxed
Dip into your pension early and HMRC will grab more than their share, says Paul Lewis
A growing number of people are taking money out of their pensions in their 50s and early 60s. The general advice is: don’t, because the money is for when you retire! But with the cost-of-living crisis and a record number of people unable to work through disability or other reasons, it’s no surprise that nearly two million people a year are releasing at least some of their pension.
But if you’re one of them, a nasty surprise awaits: HMRC will take a big chunk of it, much more than you actually owe. The first quarter of your money will be tax-free (sometimes more than that, so always check with your pension provider), but the rest is routinely overtaxed.
For example, if your income is £20,000 and you withdraw all your pension fund worth £30,000, then a quarter of that (£7,500) will be tax- free. The balance of £22,500 is taxable so it is added to your income. It should be taxed at the basic rate tax of 20 per cent, which is £4,500. But that’s not what happens. Instead, HMRC assumes that the £22,500 from your pension will be a regular monthly income and it assumes your annual income has gone up by £270,000!
So a lot of the £22,500 will be taxed at the high-earners’ rates of 40 or even 45 per cent (both slightly higher in Scotland). Your pension provider must hand over £8,400 of your pension money to HMRC, overtaxing you by £3,900. The exact amount varies but you can work it out at fidelity.co.uk/retirement/pension-tax-calculator.
At the end of the tax year, HMRC should adjust your tax code so you get the overpayment back by paying less tax next tax year. But you can claim it all back at once, as nearly 400,000 people have done in the past eight years, to recover more than £1 billion in overpaid tax. The average refund in the past 12 months was £3,269.
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You need a form: P55 or P53Z or P50Z. Work out which one is right for you by searching “flexibly accessed pension” on gov.uk. And get free advice on accessing your pension by calling MoneyHelper on 0800 011 3797 in working hours.
QUESTIONS? Send any questions to Paul.Lewis@radiotimes.com. Paul cannot answer you personally, but will reflect them in his column.