Pension tax explained
Under the pension freedom rules everyone is allowed to withdraw the first 25% of their pension balance tax-free. After this, income tax is due on the remaining 75% and you will be charged at your marginal rate.
However, if you are making a withdrawal over the initial tax-free amount for the first time, it is likely you pension provider will place you on an emergency tax code. Pension providers are required to do this if they don’t have an up-to-date tax code which takes into account your total earnings for the year.
Emergency tax on pension lump sums
Whenever you withdraw a taxable lump-sum from your pension an emergency tax rate will be charged unless your pension provider has a valid P45, which documents your earnings for the year, or has received an up-to-date tax code from HMRC.
As pension tax works in the same way as income tax, your pension provider will use the Pay As You Earn (PAYE) system to deduct any tax due before you receive your payment. Under PAYE, any payments you receive will be treated as though they will continue to be paid each month like a regular salary or income.
That means that where it is your first payment, an emergency tax rate will be applied to ensure enough tax is being collected against your predicted total earnings for the year (12x your first withdrawal amount). You’ll also only receive 1/12th of your personal allowance, which is the amount of income everyone is allowed to receive before tax is charged.
If your tax code ends in ‘M1’ which stands for ‘Month 1’, you’ll know that your payments are subject to an emergency tax rate pension withdrawal. For most people being placed on pension emergency tax will result in an overpayment of tax which will need to be recouped from HMRC.
Claiming back emergency tax on a pension
You can reclaim emergency tax on pensions by contacting HMRC directly. They will check your tax record and, once you’ve settled any outstanding amounts due, they will issue a new tax code to your pension provider. The new tax code may be used to calculate the tax due on all future withdrawals, offsetting the amount you have already paid, however this is at the discretion of your pension provider.
If, however, you have chosen to withdraw your whole pension pot as a lump sum, claiming emergency tax back from pension payments in future won’t be possible. If you’d like to get back your emergency tax pension as soon as possible you’ll need to fill out a HMRC claim form. Alternatively, you can wait until the end of the tax year when a tax refund will be generated automatically.
If you have any queries surrounding emergency tax and your pension, feel free to contact your personal BeeKeeper who will be more than happy to help!
Last edited: 17-09-2019