BBC’s money box reported this week that their research has shown that HMRC has taken over £1bn too much tax from pension scheme lump sums.

The issue comes down to the way that the PAYE (Pay As You Earn) system taxes an individual when they first start to take income or change income. The system assumes that the income you get is going to be stable through the year and doesn’t deal well with large fluctuations.

So if you have pension income of £12,000 a year and earn £1,000 a month you are below the income tax threshold and pay no tax. If you then take out a £20,000 lump sum under the pension freedoms rules, which should push you into basic rate tax and subject to 20% for the year you might expect to pay £4,000 on that lump sum. However, in many cases taxpayers are being charged 40% or even 45% tax on their income as HMRC’s system assumes that if you are paid £21,000 (ie the usual £1,000 plus the £20,000 lump sum) a month and will continue to do so, as such it works on the basis that your income for the year will be £252,000 a year rather than the £32,000 that is more likely.

In theory the PAYE system should then adjust accordingly to result in a repayment of overpaid tax, but many pensioners are finding that this just isn’t happening.

It is possible to fill a form to request a repayment. These forms are found on HMRC’s website and there are three versions of the “mini tax returns”, depending on your circumstances. The “P55 form” should be used if you’re making a partial cash withdrawal. If taking an entire pension as cash, you must either fill in “P50Z” (if you’ve stopped working) or “P53Z” (if you’re still receiving earned or other income). These can be filled in online or submitted on paper.

It’s vital to check if you think that you might have been overtaxed on your pension and we’d be happy to review your circumstances to see if you should be due a repayment of tax.

Contact us at info@fusionpartners.co.uk for more information.