Pension commentators have highlighted that current HM Revenue & Customs (HMRC) policy on taxing flexible drawdown withdrawals is unacceptable, with some claiming that it could lead to draconian tax penalties, made worse during the current Coronavirus pandemic.
Since the introduction of pensions freedoms in 2015, over-55s have been able to access their pension in a flexible manner, rather than having to take it as a regular income.
HMRC figures show that around 330,000 people over 55 have accessed their pensions flexibly during the first quarter of 2020 alone.
Many of these withdrawals are being made by retired individuals drawing fairly small amounts at regular intervals that would not attract a big charge. However, some investors have taken lump sums to bridge income shortfalls as a result of the Coronavirus.
Research has suggested that the initial tax payable on these lump sums can be significant, which could cause financial hardship.
Currently, those taking a lump sum automatically pay emergency tax on a “month one” basis, regardless of income. They then have to fill in complicated HMRC forms to claim back any excess tax paid, which will be returned to them in 30 days. Anyone who does not claim in this way will automatically receive a refund at the end of the year. A very long wait for the ill-informed.
With many people already in financial difficulties having lost their jobs, or suffering reduced income during the pandemic, this overpayment of tax and delay with its repayment could have a real impact on their everyday lives.
The way these lump sums are taxed has been widely criticised with calls for the system to be made more equitable. In my opinion, the very least the tax authorities should do is allow fairer initial deductions. During the current crisis, this system now looks totally unfit for purpose; HMRC should conduct an urgent policy review, prompted, if need be, by government.
HMRC have commented that nobody will overpay tax as a result of taking advantage of pension flexibility as individuals can claim back any overpayment. However, without proper advice, many will not know about the claim system and will end up waiting until the end of the year for a refund. Even if they do make an immediate claim, they will be out of pocket for up to 30 days.
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