The 2019/20 tax year was a record year for the amount of emergency tax applied to pension withdrawals, with HMRC revealing it repaid £166,619,969 to people it had initially deducted too much tax from.

In the first quarter of 2020, HMRC also announced that it had processed 6,286 P55 forms, 2,973 P53Z forms, and 1,138 P50Z forms – with the total value repaid during the three months reaching £32,659,329.

The figures were released on the same day that HMRC revealed £2.5bn had been withdrawn from pensions flexibly in the first quarter of the year, a 19% increase from £2.1bn in the opening quarter of 2019.

HMRC states that pension freedom tax rules allow members of defined contribution pension schemes to access their pension savings early, provided they have reached the required minimum pension age, which currently sits at 55.

Canada Life technical director, Andrew Tully, commented: “Beware of the sting in the tail if you are considering using your pension as a cash machine. Any withdrawals over your 25% tax-free allowance are taxed as income.

“However, HMRC often requires the first withdrawal to be taxed at the emergency rate, which normally means too much tax is deducted. This can catch people out, for example those who are planning to use the withdrawal for a specific purpose and haven’t factored in the tax that is due.
 
“The whole system is complex and there is a clear need to review how it works in practice given we are now five years into the freedoms.”

AJ Bell senior analst, Tom Selby, added:“Anyone planning to access their pension in the new tax year – including those looking to use their retirement pot to plug an income gap resulting from Covid-19 – needs to be aware of the impact Month 1 taxation will have on the amount of money they receive initially.

“For those taking a regular stream of income, HMRC should automatically adjust your tax code so you receive the right amount in subsequent months.

“However, where you are making a single withdrawal in the tax year you will either have to fill out one of three forms or wait for the Revenue to sort out your tax position.”

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