If you choose to take advantage of the Pension Freedoms act and take a lump sum from your pension pot, you could end up paying too much in tax.
Since the introduction of the Pension Freedoms Act, savers are now able to access their pension pot at the age of 55 and take up to a quarter of it tax-free. Any withdrawals on the remaining 75 percent are taxable at the individual’s current income tax rate. However, the Inland Revenue is having a few teething problems when it comes to The Pension Freedoms. As a result, many savers withdrawing a lump sum from their pension pot for the first time, are being charged emergency tax rates instead of their current tax rate.
Why Am I Charged Emergency Tax?
Unless your pension provider holds an up to date tax code for you, the Inland Revenue will automatically charge any taxable pension withdrawals at a higher emergency rate. This is because they assume that the amount withdrawn will be repeated on a weekly basis. Although the figures can be adjusted at a later date, you could find yourself seriously out of pocket in the meantime.
How Can I Avoid Paying Emergency Tax?
To avoid falling into the Emergency Tax nightmare, you need to make sure that your tax code is up to date before withdrawing a lump sum from your pension fund. The easiest way to do that is by taking an initial nominal payment from your pension fund, which could be as little as £1. Then wait for your tax code to update before taking the larger lump sum. By priming your Pension provider this way, you can ensure that your any withdrawals above 25 percent of the lump sum, will be charged at your normal tax rate.
What Can I Do If I’ve Already Been Charged the Emergency Tax Rate?
If You’ve already been stung by the higher rate of tax, you can either wait for the Inland Revenue to refund the overcharged money or you can fill in one of three forms to claim it back. Follow the links below to get the relevant form:
Form P55 – For partial withdrawals from your pension fund
Form P5OZ – For Individuals withdrawing their entire pension pot
Form P53Z – For Individuals withdrawing their entire pension pot and still getting an income
Andrew Colyer-Worsell, the Senior Pension adviser from Fix My Pension, said “It can be frustrating when you’re charged more tax than expected when withdrawing a lump sum from your pension pot. However, overpaying tax can be easily avoided with a little bit of preparation beforehand. A good Independent Financial Adviser should be able to help you avoid any pitfalls. ”
Further Reading: I Want My Cash Early – What an I Do?