Emergency tax on first pension withdrawals prompts large refunds

Thousands of pension savers are reclaiming money after being charged emergency tax on one-off pension withdrawals, new analysis shows, highlighting a system where the way pension income is taxed can lead to substantial overpayments. In the 2023-24 tax year, about 60,000 savers filed claims for refunds, with the average repayment around 3,342 pounds and a significant minority receiving far more. A small number of cases topped 100,000 pounds, and around 2,400 individuals were refunded more than 10,000 pounds. The total amount refunded since the pension freedoms began in 2015 runs into the billions.

The refunds stem from HMRC’s emergency tax code, which is applied when a first withdrawal from a defined contribution pension is treated as if it will be a repeat monthly income for the rest of the tax year. This can dramatically inflate the tax bill on what may be a single, irregular withdrawal. The system works in part because the initial 25% of a pension withdrawal is tax-free, and the remainder is taxed as income. However, if the first withdrawal is large or lump-sum, HMRC’s month-one calculation can assume a higher ongoing monthly income than will actually occur, leading to...