Could you be one of thousands who are overpaying tax on your pension?

Since 2015 when the government introduced Pension Freedoms, you’ve had more flexibility in how you can access your pension. This has meant that buying an annuity isn’t the only option – you can also use flexi-access drawdown to withdraw lump sums as and when you feel it’s needed.

This has been good news for retirees, who now have more control over their retirement income, but it has created some challenges related to tax.

The way that HMRC measures your income and assigns your tax code still hasn’t quite caught up with the way that people tend to access their pensions. As a result, many end up overpaying tax in retirement.

Recent data reported in FTAdviser suggests that, since 2015, HMRC has had to repay almost £1.2 billion in overtaxation – £38 million of which was repaid in Q4 of 2023.

Overtaxation can affect how much of your savings you can use to fund your preferred lifestyle in retirement. Read on to learn more about how it can occur and what to do if you think you might be owed a rebate.

Overtaxation can happen if you withdraw a large lump sum from your pension

One of the benefits that drawdown offers is the ability to take a lump sum from your pension at any time after reaching retirement. Usually, you can take a 25% lump sum from your pension tax-free when you first reach pension age (currently 55, rising to 57 in April 2028), but any subsequent withdrawals are taxed at your marginal rate.

The difficulty can occur if you don’t yet have a tax code. In this scenario, if you make a withdrawal from your pension, HMRC will assign you an emergency tax code and assume that you will make the same withdrawal every month.

Of course, if you’ve taken out a lump sum that is intended to last you for some time, you’re unlikely to make the same level of withdrawals every month. This is why so many retirees end up overpaying tax, particularly when they first start to access their pension.

Keep track of your retirement income and taxes to check if you have overpaid

After you have exceeded your tax-free lump sum, the same rates of Income Tax apply as they do to employed income. In 2024/25, these are as follows:

By keeping track of the income you have taken in retirement and the amount of Income Tax you have paid, it will be much easier to spot if you have overpaid tax in a given year.

Remember that you will need to include all types of income in your calculations, including:

• State Pension

• Rental income

• Pension withdrawals

• Employment earnings

• Dividends that exceed the Dividend Allowance

If you have multiple income streams in retirement, it can be more challenging to keep track of how much tax you need to pay. Keeping clear records and checking your finances on a regular basis can be a big help.

Remember to reclaim any overpaid tax you are owed

If you notice that you have overpaid tax, you can reclaim the excess and HMRC will return it, usually within 30 days.

You can complete the form online or print and return a hard copy to HMRC. The correct form to use will depend on your circumstances.

• Use form P55 if you’ve flexibly accessed part of your pension.

• Use form P50Z if you’ve stopped working and have accessed all of your pension.

• Use form P53 if you’ve taken a small pension as a lump sum.

Get in touch

If you’d like to learn more about how we can help you to ensure you pay the right amount of tax in retirement so that more of your savings can be used to help you achieve your goals, please get in touch. Our friendly team in Towcester will be delighted to assist you.

Email theteam@fortitudefp.co.uk or call us on 01327 354321.

Please note

This article is for general information only and does not constitute advice. The information is aimed at retail clients only.

Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.

The Financial Conduct Authority does not regulate tax planning.

A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.

The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.