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HMRC emergency tax catching out savers to tune of £600m+

11 May 2020

Pension savers seeking to access their pension in the new tax year, particularly those seeking to counter the effects of Covid-19, need to factor in HMRC’s emergency tax rules. 

According to the rules, pension providers are required to apply an emergency ‘Month 1’ tax code to the first withdrawal. As a result, savers will only receive 1/12th of their available tax allowance.

As an example, if someone makes a pension withdrawal of £12,500, only £1,042 of the withdrawal is tax-free, with the next £3,125 taxed at 20% and the remainder taxed at 40%, resulting in a total tax bill of almost £4,000.

Official figures from HMRC have revealed that pensioners have now reclaimed £600 million. Over 10,000 reclaim forms were processed by HMRC during the first quarter of this year alone, with the average person receiving a refund of £3,141.

Tom Selby, senior analyst at AJ Bell, has warned that people dipping into their pensions as a result of Covid-19 risk getting thousands of pounds less than expected due to the rules.

Selby said: “While the freedom and flexibility pensions now offer has been welcomed by millions, HMRC’s insistence on applying a ‘Month 1’ emergency tax code to the first withdrawal of the tax year has now seen savers reclaim £600 million in overpaid tax.

“It’s worth remembering this only covers those who have made a reclaim using the official forms, and so doesn’t include any people refunded via HMRC’s systems at the end of the tax year. Anyone planning to access their pension in the new tax year – including those looking to use their retirement pot to plug an income gap resulting from COVID-19 – needs to be aware of the impact Month 1 taxation will have on the amount of money they receive initially.”

Selby added that for those taking a regular stream of income, HMRC should automatically adjust their tax code so they receive the right amount in subsequent months.

“However, where you are making a single withdrawal in the tax year you will either have to fill out one of three forms or wait for the Revenue to sort out your tax position.”

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