I cashed in my £91k pension to buy a house but was overtaxed

I cashed in my entire private pension which was £91,000. I received around £62,000  and I applied for tax back four months ago.

I still work but have been off the last five months with anxiety and depression, so obviously haven’t earned the same as usual. I’ve earned just over £8,000 this year.

I bought a small terraced house with the pension money but I still haven’t heard anything about the tax.

Tax bill: I cashed in my £91,000 pension to buy a terraced house (Stock image)

I was asked for more information about my payment as the taxman had been told I received two payments, but I confirmed I received one and got my pension company to do the same.

That was three months ago. I spoke to someone who said I would hear by 16 April but I still haven’t. Is this usual?

SCROLL DOWN TO FIND OUT HOW TO ASK STEVE YOUR PENSION QUESTION    

Steve Webb replies: When you take money out of a pot of money pension, the first 25 per cent is generally tax-free and the balance is subject to income tax.

But there is a real problem with HMRC deducting too much tax and then expecting people to claim back the excess, and it sounds as though this is the problem you have faced.

Suppose we take a simple example of a pot worth £40,000, which someone withdraws in full.

Steve Webb: Find out how to ask the former Pensions Minister a question about your retirement savings in the box below

Steve Webb: Find out how to ask the former Pensions Minister a question about your retirement savings in the box below

They can take £10,000 tax free, and the remaining £30,000 is treated as taxable income.

If this was literally their only taxable income for the year, the first £12,500 would be ignored, because it comes under the tax-free personal allowance, and the remaining £17,500 should be taxed at the basic rate of 20 per cent, giving a tax bill of £3,500.

Unfortunately, this is not how HMRC work out the tax on what are called ‘flexible’ pension withdrawals.

What they do is assume that you are not just going to make this one withdrawal but that you are going to take repeated withdrawals over the course of the year.

If that assumption was correct then you would be pushed well into the higher income tax bands and you could easily find 40 per cent of your withdrawal being withheld by the tax office.

Because this assumption is not true for most people, you can then fill in a form to claim back the excess tax. Amazingly, there are three different forms to choose from:

• Form P55 is for those who make a partial, one-off withdrawal and are not going to make regular withdrawals.

• Form P50Z is for those who have emptied their pension pot and are no longer working

• Form P53Z is for those who have emptied their pension pot but are working or receiving benefits;

More information on how to apply to reclaim your tax can be found on the Government website.

If you do not fill in a form then HMRC will generally sit on the extra tax until you fill in a tax return and they can then work out how much you have been over-taxed.

It is quite shocking that people are routinely over-taxed in this way, and since the Pension Freedoms were introduced in 2015 people have had to claim back over £600m in excess tax on pension withdrawals.

When challenged, HMRC say that if people do fill in the forms they are usually processed in around six weeks.

HMRC say it is more important that they collect all the tax that might be due and issue refunds where appropriate rather than not taking enough tax for some people and having to collect the rest through a separate process.

In your particular case, it sounds as though you made the withdrawal in the last tax year (2019/20) and you should certainly have received any refund by now.

It may be that they needed extra information before they could work this out, but I would encourage you to chase them up.

Without knowing your other income for 2019/20, I cannot tell whether you are due a refund, but many people in your situation are due some tax back, and you should not have had to wait this long.

ASK STEVE WEBB A PENSION QUESTION 

Former Pensions Minister Steve Webb is This Is Money’s Agony Uncle.

He is ready to answer your questions, whether you are still saving, in the process of stopping work, or juggling your finances in retirement.

Steve left the Department of Work and Pensions after the May 2015 election. He is now a partner at actuary and consulting firm Lane Clark & Peacock.

If you would like to ask Steve a question about pensions, please email him at [email protected].

Steve will do his best to reply to your message in a forthcoming column, but he won’t be able to answer everyone or correspond privately with readers. Nothing in his replies constitutes regulated financial advice. Published questions are sometimes edited for brevity or other reasons.

Please include a daytime contact number with your message – this will be kept confidential and not used for marketing purposes.

If Steve is unable to answer your question, you can also contact The Pensions Advisory Service, a Government-backed organisation which gives free help to the public. TPAS can be found here and its number is 0800 011 3797.

Steve receives many questions about state pension forecasts and COPE – the Contracted Out Pension Equivalent. If you are writing to Steve on this topic, he responds to a typical reader question here. It includes links to Steve’s several earlier columns about state pension forecasts and contracting out, which might be helpful. 

If you have a question about state pension top-ups, Steve has written a guide which you can find here. 

TOP SIPPS FOR DIY PENSION INVESTORS

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