Retirement savers could face paying thousands of pounds more tax than they should when accessing flexible drawdown pensions after April.
HM Revenue & Customs (HMRC) says many pension providers will impose emergency tax coding on pension withdrawals because they do not hold the right tax codes for customers.
Taxing income under the emergency code means the pension saver could pay extra tax because of the way personal allowances are applied.
The emergency method applies the personal allowance as a monthly amount rather than an annual equivalent.
HMRC has told providers that if they have a personal tax code for a customer and their in-house software can track withdrawals, they do not need to apply the emergency code but can use the customers actual personal coding.
Emergency tax code
Pension firms who do not have a tax coding for their customers will still have to supply the emergency coding.
Although pension savers may pay more tax under emergency coding, the excess can be reclaimed from HM Revenue & Customs (HMRC), but the process can take some time and may end up being conducted through annual self-assessment system.
The Financial Times quotes a £20,000 could leave a basic rate taxpayer paying an effective rate of 36% instead of 20% on the £15,000 balance of the withdrawal which is taxable.
Instead of receiving £17,000, they would get £14,600 with the balance of overpaid tax to be refunded later.
For higher rate taxpayers, the effective rate under emergency coding would be even worse.
Tax code errors
HMRC has told pension providers to use the tax code they have on file for a customer providing their drawdown software can handle cumulative withdrawals and apply the appropriate personal tax allowances to multiple drawdowns.
However, HMRC has a track record of issuing millions of wrong tax codes in the past.
A mix of poor pension provider systems and wrong tax codings issued by HMRC could lead to thousands of retirement savers paying too much tax from April.
“It’s a good idea for anyone to check that their tax coding is right to avoid paying too much tax, “said an HMRC spokesman. “The issue is even more important for someone planning to access their pension with flexible drawdown.”
Information about how to check a tax code is available on the HMRC web site.
