HMRC has pledged to overhaul the way pensioners are taxed on money they take out of their pension fund after it had to refund pensioners nearly £50 million.
The average tax refund per taxpayer was £3,390 per person.
HMRC said it would be improving how tax code information is used. Currently pension withdrawals are taxed using a temporary emergency code, which then means thousands of retired savers end up paying too much tax.
Then they have to submit a tax return to claim it back.
An emergency tax code means the entire withdrawal of cash is taxed at either 20% or 40% rather than allowing for a personal tax-free allowance or any tax-free cash allowance.
At least £1 billion has been reclaimed by people who were overtaxed after taking money out of their pension.
The issue dates back to pension freedoms introduced in 2015. These changes meant retirees could access their pension savings at 55, but taking cash out of pension means it is subject to tax.
Myron Jobson, senior personal finance analyst at interactive investor, said automatically updating tax codes for pensioners on temporary codes is a significant step forward in simplifying what can often be a confusing process.
“For too long, pensioners have borne the brunt of systemic inefficiencies, with many unknowingly overpaying tax and waiting months for refunds. The recent revelation that HMRC refunded nearly £50 million in just three months underscores the scale of the issue.
“This change not only ensures that pensioners are taxed more accurately in real time but also reduces the financial and emotional stress of overpayment.”
Jon Greer, head of retirement policy at Quilter, said HMRC’s plans to streamline tax coding from April 2025 were a welcome step and would reducing the paperwork needed to be filling in by savers as well as minimise any overpayments made in the first place.
He said: “The root of the issue lies in a tax system that has struggled to adapt to the pension freedoms introduced in 2015. The PAYE system, while efficient for regular income, frequently applies emergency tax codes to one-off withdrawals, resulting in significant overpayments.
“While the planned reforms to automatically update tax codes for new pension recipients are promising, it remains to be seen whether they will fully address the complexities and inefficiencies of the current system.
“Until systemic reforms are fully implemented, retirees will continue to face the risk of significant overpayments and the need to navigate a cumbersome claims process to reclaim their money. HMRC’s efforts to address these issues are a step in the right direction, but there is still a long way to go to build a system that works seamlessly for savers.”
