A new report that has been commissioned by the government has called for a rethink on the use of the emergency tax code on pension withdrawals.
Currently, pension freedom payments are taxed at an individual's marginal rate, but if they draw a large amount in a single month, then they can be taxed at a higher, emergency rate of tax. Then, individuals have to claim this back from the HMRC by filling in a form. However, not everyone does this. According to the latest figures, over tax on pension payments now amounts to £300 million.
The report for the government has been undertaken by the Office of Tax Simplification (OTS), an independent adviser to the Treasury.
"On pension income, particular difficulties arise for taxpayers concerning the treatment of lump sum withdrawals from personal pensions," the report said.
"These are an increasing feature of the pensions landscape. In addition, people who deferred taking the state pension before April 2016 have an option to receive a lump sum payment of deferred income: gov.uk does not explain the special tax treatment of these payments and this causes much confusion."
The report went on to say it wants to work with the government to look at alternatives to the emergency tax code system.
"More could be done to help people understand the tax implications of withdrawals from pension funds and the actions they may need to take. The OTS would like to explore this further with HMRC, in addition to working to identify options other than initial tax deduction using emergency tax codes on personal pension lump sums, which generally results in the deduction of too much tax when the payment is made."
The former pensions minister, Sir Steve Webb has welcomed the report. He said:
"It is very welcome that an official body like the Office for Tax Simplification has recognised that the current way pension withdrawals are taxed is baffling. The system is run for the convenience of HMRC not the taxpayer. It is totally unacceptable that tens of thousands of savers have had to fill in forms to claim back over £300m in overpaid tax in the last three years. The sooner HMRC work with others to come up with a fairer and simpler system, the better."