The pension rules opened up a lot after 2015, giving you way more freedom over how you get your hands on your hard-earned savings. Under these “Pension Freedoms” rules, once you hit the ripe old age of 55 you can start pulling cash out of your pension pot. The first 25% is tax-free, with any further withdrawals being taxed at your marginal income tax rate. “Marginal”, in the taxman’s language, just means the percentage of tax you’d be charged on the next £1 you made that tax year.

So, if it’s all as simple as that, why is HMRC paying out a grand total of £42 million in refunds to an incredible 13,000 pension savers for the last quarter alone? In fact, since the Pension Freedoms system first kicked in, it’s had to refund around £835 million to cover overpayments made when people drew cash from their pension funds.

Well, it all comes down to tax code mistakes. When you’re taking enough out of your pension to pay tax on the amount, there’s a good chance you’ll get hit with an emergency tax rate because your pension provider doesn’t have an up-to-date tax code for you. Basically, your provider probably won’t know what your marginal rate’s supposed to be because you didn’t have a current P45 to show them. You’d only normally get a P45 when you leave a job, so most people drawing from their pensions don’t have one to show. It’s a system that’s seeing a lot of people forking over big chunks of their savings to HMRC. As former Pensions Minister Steve Webb puts it:

“HMRC’s approach is to tax first and ask questions later... It would be much fairer simply to deduct basic rate tax from pension withdrawals and then adjust the amounts paid if this did not give the right answer, rather than overtaxing thousands of people every month”.

The figures we’re seeing for refunds here could actually be just the tip of the iceberg, since they only count people who’ve actively claimed them. Since HMRC has systems in place that are supposed to handle problems like this automatically at the end of the tax year, the actual amount refunded since 2015 could be as high as £1 billion or more.

For those not happy to wait for HMRC to catch up, the form you need to claim your refund depends on your situation. If you’re draining your entire pension pot in one go, you’ll use:

  • P53Z if you’ve got any other taxable income (earnings, state benefits, etc.)
  • P50Z if you’ve got no other taxable cash coming in.

On the other hand, if you’re only taking out a portion of your overall pot, you’ll need form P55 to get your tax refund. You can find all the digital documents over on the HMRC website, either to fill in online or to print out and post. Either way, you’re supposed to get your refund inside about 30 days.

Of course, this is all part of the much wider situation around tax codes. Being on the wrong tax code can end up costing you thousands of pounds – and if you’re not on your toes you might never even realise you’re losing out. That’s why, whether you’re drawing from a pension or not, it’s so important to check your tax code regularly.

That’s something we always do at RIFT when we handle your yearly tax refunds. HMRC will sometimes change your tax code when you claim a refund, on the assumption that you’ll always have the same expenses year-on-year. For most people, that just isn’t the case, leaving them on the wrong tax code the next time they claim. Whenever that happens, we swoop in to fix the problem before it costs you any money – and that’s just one more reason why you’re always better off with RIFT.