Pension tax overpayments: £49m handed back to savers in last three months

HMRC is finally addressing the long-running issue of savers being wrongly hammered when accessing pension cash, but its plans will only help some of those affected.

HMRC has been forced to repay £49 million to savers who were wrongly taxed when accessing their pension funds in the final quarter of 2024, official figures show.

Between October and December 2024, the taxman refunded 14,600 claims with the average sum worth around £3,350.

It means a staggering £1.37 billion has now been repaid to savers who were overtaxed on their first withdrawal and filled out the relevant HMRC form to claim their money back.

Read: how to avoid the pension withdrawal emergency tax

How pension savers get wrongly taxed

Being able to tap into our pension funds as we see fit has been one of the big selling points of the pension freedoms, and that facility has likely been even more valuable given the cost of living crisis.

It means savers have been able to boost their own incomes, or even offer some financial support to loved ones who are in a more precarious position with their money.

However, there remains a significant downside to the pension freedoms ‒ the potential for being overcharged tax when making withdrawals.

It all comes down to the way that HMRC handles certain withdrawals, where the tax is calculated using a higher-rate emergency tax code.

In effect, the lump sum you take out is treated as if that sum will be withdrawn every month, with the knock-on effect that would have on your overall income for the year.

So if you took out £5,000, it would be taxed as if you were going to be withdrawing £60,000 for the year.

That would mean your income is treated as if you are in the higher Income Tax band, when the reality may be that for the year you bring in less than the £12,500 personal allowance, which should mean you pay no tax at all.

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Total tax bill likely far higher

The £49 million refunded in the last quarter is an astonishing amount of money at the best of times, let alone in the middle of a cost-of-living crisis.

It’s worth remembering that these are just the people who opted to put in a claim for tax overpayments now ‒ there will be many more who do so at the end of the tax year.

What’s more, there will be some who are simply unaware that they have been overtaxed and so don’t actually make a claim.

In other words, this £49 million in repaid tax is most likely just a fraction of the overall amounts that have wrongly ended up in the taxman’s coffers.

What’s more, the money repaid quickly adds up.

As mentioned earlier, savers have reclaimed £1.37 billion in over-taxation on pension withdrawals since 2015, according to analysis by financial firm AJ Bell.

Taxman finally addressing the issue

The good news is HMRC is finally taking steps to address the long-running issue.

From April, it will automatically update tax codes for those on temporary tax codes who would benefit from being on a cumulative code, meaning they won't be hit with an overpayment or underpayment at year-end.

However, as Helen Morrissey, head of retirement analysis at Hargreaves Lansdown, points out, this will only help some of those affected.

“More than £49m has been refunded over the past three months as the pension tax saga rumbles on," she explained.

"Over 14,600 forms were submitted by people looking to reclaim their hard-saved money after they had been placed on an emergency tax code.

"This treated the first payment as being repeated every month, so if you’ve taken a large payment, you could be landed with a sizeable surprise tax bill.

"Of course, the money can be refunded, but it’s an unnecessary complication that threatens to cause chaos for people’s retirement plans.

"Almost 10 years on from the introduction of Freedom and Choice, it’s a problem that should have been solved long ago.

"HMRC has announced that from April it will automatically update tax codes for those who are on a temporary tax code and would benefit from being on a cumulative code.

"This means they’ll avoid an overpayment or underpayment at the end of the year.

"This is great news for those taking regular income from income drawdown, but the problem persists for those taking lump sums.

"In the meantime, you can take steps to mitigate this – for instance by making your first pension withdrawal a small one if possible.

"If you do get landed with a bill, then you can get it sorted quickly by filling out a form and getting your money back as soon as possible.

"Otherwise, you will get your money at the end of the tax year.”