The £1 Loophole That Could Save Your Pension

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Are you worried about getting heavily taxed on your pensions savings? Well, you’re certainly not alone – and many have been taking advantage of a loophole that prevents them from being hit by a HMRC ’emergency tax’.

It’s all down to the way the tax system works when it comes to pensions. See, the moment you withdraw a lump sum from your savings, HMRC will instantly assume that you’’l be withdrawing this amount each and every month. And you’ll be taxed at that level from then on, even if that withdrawal was a one-off.

For example, if you withdraw a £10,000 lump sum from your pension, it should technically be tax free. But the tax man will then place an emergency tax on that amount, meaning savers will pay more than £3,000 on their savings. And that’s just plain wrong, since £11,500 is the current personal tax allowance – the amount you can have without having to pay tax. The upshot is that many retirees will be forking out thousands of pounds in tax they don’t really owe.

One unlucky retiree, Paul Beardsmore, told The Telegraph newspaper that despite explaining to HMRC that £1,500 withdrawals only happened twice, they refused to alter his tax code to what it should be. He said:

‘I’ve deferred taking my pension but about a year ago started looking in the mechanics of taking money out. I assumed you’d be taxed but when I saw I was going to be taxed at this enormous rate it was quite a shock. It seems funny to me that someone with a small pension pot would be assumed to be taking out the same amount each month. My provider also charges you each time you make a withdrawal, so I don’t want to make as few withdrawals as possible.’

Unfortunately, pension providers say there is nothing they can do to stop HMRC from applying the emergency tax code, even if retirees shouldn’t technically be taxed at the higher rate. It is possible to get a refund on undue taxes, by contacting HMRC with the appropriate claim documentation, which should see the amount refunded within 30 days. The problem, of course, lies with the tax man, but it’s pensioners who are paying the price. Indeed, pension provider Royal London’s Steve Webb has called on HMRC to ‘make life simpler for savers rather than simpler for the Government’ adding that:

‘It is useful for people to know that there are ways to avoid facing a huge up-front tax bill when taking advantage of the new pension freedoms. But it is also an absurd situation when people have to find ways to fight back when HMRC decide that they will simply take huge amounts of tax up-front and leave people to claim it back or wait for an eventual refund.’

But there is hope: The ‘£1 trick’.

It’s based on the idea that, by taking smaller payments the tax code should be correct for all future withdrawals. Is something that Chris Dando at Burfield Financial Planning admits to advising people to do.

‘So, if we take an initial £100 or even £1 then HMRC will be aware and change the tax code accordingly. This ensures the correct tax code is used from the first proper payment. The only downside is that it slightly delays the process, as it may be another three or four weeks before the correct code is applied to future payments. So, people who are desperate to get their money might be better off taking the money on an emergency basis and then claiming the rest back later.’

It’s not a fool-proof method – it’s possible that savers receiving a certain level of income will still be forced to reclaim tax – but it’s one way to save your savings.

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