An advisory body to the Treasury has called for a rethink of the rule under which thousands of savers are taxed at emergency rates on lump sums taken from their pensions.
Since “pension freedoms” came into force in 2015, many thousands of over-55s have taken advantage of the new flexibility to withdraw lump sums from retirement pots.
However, savers who do not have an up-to-date tax code have seen the money taxed at an “emergency” rate, resulting in a much bigger chunk of their pension subjected to tax. Savers then have to claim back the money .
In a report published on Friday, the Office of Tax Simplification said the use of the emergency tax code for pension lump sum withdrawals should be reviewed. “More could be done to help people understand the tax implications and the actions they may need to take,” said the OTS.
It said it wanted to further “explore this with HMRC, in addition to working to identify options other than initial tax deduction using emergency tax codes on personal pensions, which generally results in the deduction of too much tax when the payment is made.”
The OTS said the fact that the taxation of pension lump sums was “not easily understood” by many recipients resulted in “extensive queries as well as claims for repayment”.
“It is therefore quite possible that some pensioners do not make claims due to a lack of understanding of the correct tax treatment,” said the report, which made wide-ranging recommendations.
The OTS said HMRC had advised that it was making repayments within seven days in response to claims of overpaid tax on lump sums, but pension providers told the OTS that some delays were as long as six weeks.
“The recommendation to review the tax treatment of pension withdrawals is extremely welcome,” said Steve Webb, director of policy at Royal London, a pension provider.
“The current approach by HMRC is in effect to tax first and ask questions afterwards.
“People are routinely paying far too much tax and having to claim it back, with about £300m overpayments having been reclaimed since the start of pension freedoms. A much simpler system would put the needs of the taxpayer before the convenience of HMRC.”
In the report, the OTS also noted that guidance on the tax treatment of state pension lump sums was “difficult to locate” — with a government website not covering taxation of deferred lump sums.
“The OTS should welcome the opportunity to work with HMRC and other stakeholders on options to simplify the tax treatment of pension income,” said the OTS.
The report, which did not consider tax relief on pensions, made various recommendations to make the tax system less complex for savers.
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