Time for taxation of flexible pension payments to come of age

When George Osborne dropped his pension freedom bombshell in his now infamous budget I was on maternity leave. That child is rapidly approaching his 9th birthday and looking at him makes me realise how long ago those announcements were made and shake my head in bewilderment at the fact so many payments under these “new” rules are still taxed incorrectly.

The issue with over-taxation lies with ad hoc pension payments – either under flexi-access drawdown or uncrystallised funds pension lump sums (UFPLS).

The amounts involved are not insignificant. In the latest Pension Schemes Newsletter (July 2022) the total value of repayments HMRC made to those that had overpaid tax from 1 April 2022 to 30 June 2022 alone was £33,689,819 from just over 10,000 reclaims.

Since April 2015 HMRC has processed over 330,000 reclaim forms in total and repaid close to £900,000,000. We are on course for the magic £1 billion mark to be reached within the next 12 months – and the trend is for the quarterly reclaims to keep getting higher.

Even more worryingly the published figures don’t give the whole picture when it comes to overpayment of tax. They are only the figures for those that take the time to complete the paperwork for in-year reclaims. There will be many more who are happy to wait for the P800 calculation, either because they have smaller claims or because their payments are due near the end of the tax year. And, of course, there will always be some who simply will not realise they have overpaid tax.

This issue has been raised with HMRC on many occasions, both by the industry and the Office of Tax Simplification. One argument I have seen from HMRC is that in its view it is better for those on low income to be overtaxed initially, so they don’t have a tax bill later once the money is spent.

However, it seems very inefficient to me, in cases where the member has told their scheme administrator that they are only taking one payment in the tax year, to deduct tax at a rate that will never be correct.

Instead, we would like to see a more pragmatic approach from HMRC, so where the member has made it clear they only intend to take a one-off payment in the tax year we can use a “month 12” basis – effectively giving the whole personal allowance for the payment, and the full tax bands after that. Yes, there is a risk that if the member changes their mind and they need to take a subsequent payment in the year then they would face higher tax charges relating to these later payments, but warnings could be given when the first payment was made, and these cases would be the exception. Surely it’s got to be better for a few to be taxed incorrectly, rather than the thousands we have now.

Let’s just hope it’s not another nine years, and my son’s not on his first legal pint, by the time it’s fixed.

This article was previously published by Sipps professional