Starting April 2025, HMRC will stop using emergency tax codes for individuals receiving private pensions for the first time. This move follows widespread criticism of the current system, often resulting in incorrect tax deductions when people draw their pensions.

Under the new approach, HMRC will improve how tax codes are assigned, ensuring pensioners pay the correct tax sooner. This should prevent unnecessary overpayments and reduce delays in receiving the right pension income.

For years, incorrect tax codes have led to millions of pounds in overpayments. HMRC’s failure to account for pension freedoms introduced in 2015 has caused thousands of taxpayers to be unfairly overtaxed. Those affected must reclaim their money by completing one of three HMRC forms or wait until the end of the tax year for a refund.

Automatic tax code updates

The updated system will automatically adjust tax codes for those on temporary codes who should be on cumulative codes. HMRC claims this change will eliminate tax coding errors, meaning fewer taxpayers will face unexpected deductions. Pension scheme administrators will not need to make manual adjustments, as HMRC will process updates systematically.

The changes revealed in an HMRC pension schemes newsletter have not been widely publicised. However, HMRC assured taxpayers that they would be notified by letter or through the HMRC app if they have opted for digital communication.

Despite this update, the rules for taxing pension withdrawals remain unchanged. PAYE rules will continue to apply, and those taking ad-hoc lump sums from their pension pot will still be overtaxed initially.

Ongoing issues with pension drawdowns

While removing emergency tax codes will help those receiving regular pension income, it does not address taxation issues for those making flexible withdrawals under pension freedoms.

Many have welcomed the update but criticised the Government for failing to fully modernise pension taxation. HMRC’s system still overtaxes those making one-off pension withdrawals, sometimes by thousands of pounds.

In Q4 2024 alone, HMRC processed over 14,000 reclaim forms for pension tax refunds, with an average refund of £3,389. The total overpaid tax on pension withdrawals for that quarter reached £50 million.

To avoid excessive tax deductions, pension savers planning a single withdrawal in a tax year can take a small notional withdrawal first. This allows HMRC to apply the correct tax code to subsequent withdrawals, preventing large initial overpayments.

Alternatively, those affected must fill out one of three HMRC forms to reclaim their tax:

• P53Z: For those who have emptied their pension pot and are still working or receiving benefits.
• P50Z: For those who have emptied their pension pot and are not working or receiving benefits.
• P55: For those who have only accessed part of their pension pot.

If no form is submitted, HMRC will automatically correct the tax position at the end of the tax year, but this could mean waiting months for a refund.

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