One of my colleagues sent me a link to a Radio 4 Money Box podcast where Paul Lewis stated that hundreds of thousands of people who had used pension freedoms to take lump sums had been overtaxed by thousands of pounds. He then went on to say that he had new research that suggested the Treasury had a tax windfall of more than a billion pounds in the first two and a half years since the pension freedoms began from overpaid tax that had not been refunded.
Based on the fact that £14.2bn has been withdrawn under pension freedoms over this period the Treasury would be benefiting from an additional 7% tax charge. That said there was no basis given on how the ‘windfall’ was calculated, but in my view it seems extremely high and there is good reason to question it.
The PAYE system works well when someone is taking regular income but where pensions are taken on a one off or irregular basis it does put a strain on the system and it is common for tax to be overpaid. This does give the Treasury a cash flow benefit, however even if the individual does not do a tax return or make a claim during the tax year, under the PAYE system they should, in most circumstances, get a refund automatically around November time, after the tax year. So the chances of not having overpayments refunded should be rare. The big question should be how quickly can you get your money back?
The provisions to make a claim during the tax year can be a bit complex in that there is a choice of three forms depending on circumstances. If the pension has been withdrawn in its entirety and the member has other PAYE income it’s form P53Z. If no other PAYE income or only in receipt of the State Pension then it’s form P50Z.Finally, form P55 is used if the pension fund continues.
All these problems can however potentially be removed if the pension provider operates a sophisticated payroll system and this is something that is overlooked when selecting a pension provider. For example, where a one-off payment is made and an emergency tax code applied leading to an overpayment of tax, not all payroll systems have the functionality to make a refund of the overpayment the following month, even if no further income payments are made.
There are also steps that can be taken to try and ensure the correct tax is paid when a large withdrawal is being planned. For example, if the client made a small withdrawal one month and an emergency tax code was applied, all going to plan if the large withdrawal is made the following month the correct tax code should be applied.
The PAYE system has many quirks and is reliant on an accurate tax code which can only be provided by HMRC. Although the introduction of real time information has improved the speed that adjusted tax codes can be applied, advisers should make sure their clients are aware that they may be overtaxed, what steps need to be taken to try and avoid the problem arising or if it does how to rectify things, and the time scales involved.
Unfortunately, where an individual does not get the full amount they expect the consequences of a delay in getting the tax refund may have serious consequences. I have heard of cases where people have lost deposits on buying property abroad because they failed to raise the full price of the property in time and even a situation where an individual was assaulted by a tradesman for not being able to settle his invoice on time.
So be aware of the PAYE perils.
This article first appeared on Professional Adviser
Please note that every care has been taken to ensure that the information provided in this article is correct and in accordance with our understanding of current law and HM Revenue & Customs practice. You should note however, that James Hay Partnership cannot take upon itself the role of an individual taxation adviser and independent confirmation should be obtained before acting or refraining from acting upon the information given. The law and HM Revenue & Customs practice are subject to change. The tax treatment depends on the individual circumstances of each client.