HMRC to Close Pension Tax Trap Affecting Thousands
HM Revenue and Customs (HMRC) has announced plans to close a long-standing tax trap that has seen hundreds of thousands of pensioners overcharged on their retirement savings. The issue stems from the introduction of pension freedoms in 2015, which allowed individuals aged 55 and over to access their defined contribution pension pots flexibly. However, HMRC’s use of emergency tax codes on initial withdrawals has led to many savers being overtaxed, often by thousands of pounds.
Under the current system, HMRC applies a “Month 1” tax code to the first withdrawal, assuming it will be repeated monthly. This results in savers being taxed as if they were making regular withdrawals, even if they are taking a one-off lump sum. As a result, nearly half a million people have overpaid tax since 2015, with an average refund of £2,900. In the last three months alone, £50 million was refunded to over 14,000 retirees.
From April 2025, HMRC will automatically update tax codes for those on temporary codes, moving them to cumulative codes to prevent overpayments or underpayments at the end of the tax year. This change will apply to those receiving ongoing pension payments, ensuring they pay the correct amount of tax in real time. However, the issue remains unresolved for those taking ad-hoc lump sums, who will still face overtaxing on their first withdrawal.
Former Pensions Minister Steve Webb welcomed the move, calling it a “victory” after years of campaigning. He described the previous system as “scandalous,” noting that savers had to “jump through hoops” to reclaim their own money. Tom Selby of AJ Bell warned that while the changes are a step forward, the system still fails to fully adapt to the flexibility of pension freedoms, leaving many retirees unfairly taxed.
HMRC has confirmed that affected individuals will not need to contact them, as the process will be automatic, with notifications sent via letter or digitally. The tax authority is also considering further reforms for those taking lump sums, with industry consultation expected. Despite these changes, experts advise savers to remain cautious, particularly when making large withdrawals, and to seek professional advice to avoid unnecessary tax bills.
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