Tens of thousands of people have paid incorrect tax on pension withdrawals made under new rules applying from April 2015, experts warned, as the self-assessment tax return deadline for that year passed on Tuesday night.
Many of these withdrawals will have been incorrectly taxed, accountants warn.
Reforms introduced by former Chancellor George Osborne permitted over-55s to withdraw cash from their pensions from April 2015, rather than spend the bulk of the money buying an income-paying annuity.
Errors are arising because one-off pension withdrawals have been taxed based on a tax code provided by HMRC.
When withdrawals were made, pension providers deducted tax according to the supplied code.
But this tax code, typically based on how much the person earned in the previous year, was often incorrect.
Tina Riches of accounting practice Smith & Williamson said: “Some people will have paid the right amount of tax, but the majority who took lump sums will probably have paid the wrong amount. The chance of HMRC getting it right is relatively low.
“The PAYE system doesn’t work particularly well when there is more than one source of income or where that income is taken in single sums,” she said.
Problems are especially likely to arise where one-off sums are withdrawn, for example where older savers want to raise cash to fund children’s university fees or clear mortgage debts.
George Bull, senior tax partner at auditing and consulting firm RSM, said Because regular pension payments tend to be monthly during the tax year, HMRC has time to adjust the taxpayer’s code. The issue with one-off payments is that the wrong code is frequently used.
Experts warned that HMRC could impose interest on people who fail to declare that they underpaid tax. Interest is applied to late tax payments at 2.75 per cent.
Nimesh Shah, of accountancy firm Blick Rothenburg, said: “It’s a real issue. Pension companies didn’t know what marginal rate of tax the individual should have been paying.
They were relying on information from HMRC, but very often this wasn’t correct, because someone’s income could be very different one year to the next, he said.
He warned that those whose pension withdrawals were taxed at 20 per cent, but who should have paid tax at 40 per cent, were most at risk of penalty.
This would apply to people who normally paid basic-rate tax, but who took out a large lump sum in their first year of retirement, tipping them into the higher-rate tax bracket.
Some could find that they were paying insufficient levels of tax as other sources of income, such as private pensions, were not taken into account.
Others who retired that year could have overpaid as the Government assumed they were still in work and earning a salary which would have put them in the higher-rate band.
HMRC insisted that pension freedoms were not an issue. A spokesman said: No one is submitting tax returns because of the pension freedom changes.
But Mr Shah said this was “naive” and said as many as 250,000 people could be affected.
Yesterday hundreds of thousands of taxpayers attempted to file their returns at the last minute as HMRC struggled to cope with demand for their phone lines and online chat function.
The Government said yesterday lunchtime that 1.1 million had left their online returns to the last minute and were expected to file before the deadline at midnight. More than 10.2m had already filed returns in paper or online.
It also announced that its plan to scrap the annual tax return by 2020 will go ahead, with the scheme set to pilot in April this year.
Instead of filing annually, self-employed people, landlords and businesses will have to update the Government quarterly using digital software.
The new system is due to start for landlords and self-employed people from April 6 2018.