Over-taxation occurs when HMRC taxes pension savers’ first flexible pension withdrawal on a Month 1 basis.
This can lead to an unexpected tax bill up to thousands of pounds. Those who take a regular income should have their tax code adjusted automatically but anyone who does not is likely to be overtaxed.
Reclaims have slowed with just 8,019 pension tax reclaim forms processed in Q4 2020, the third lowest figure for a quarter since records began,
Over £25m was repaid during Q4 2020, with an average reclaim of £3,213.
AJ Bell analysis of HMRC data showed that 38,000 official reclaim forms were processed by HMRC in 2020 in comparison with over 600,000 people assessing their retirement pot for the first time.
Tom Selby, senior analyst at AJ Bell, said: “There remains a serious flaw in the pension tax system which in all likelihood has left hundreds of thousands of people lumbered with a shock over-taxation bill since April 2015.
“This approach was painful before the pandemic hit but now risks adding extra financial hardship to those who are forced to dip into their retirement pot to make ends meet.
“This over-taxation occurs because when someone accesses their retirement pot ‘flexibly’ for the first time in a tax year, HMRC applies an emergency ‘Month 1’ tax code to the withdrawal. Flexibly accessing your pension includes taking income via drawdown or withdrawing ad-hoc lump sums.
“HMRC’s insistence on using a Month 1 tax code means your usual tax allowances will be divided by 12 and then applied to your withdrawal. In many cases this will lead to tax bill thousands of pounds higher than expected.
“Only those who fill out the official reclaim form will be repaid within 30 days by the Revenue. Those who don’t will likely have to wait at least until the end of the tax year for HMRC to sort out their affairs.”