Savers are being forced to resort to a “£1 trick” to make sure they don’t get stung by emergency tax levied by HMRC on their pension savings.
Because of a quirk of the tax system, if you take a lump sum from your pension the tax man assumes this amount will be taken each month.
This “emergency tax” provision means pensioners only receive a twelfth of their “personal allowance” – the amount you can earn each year without paying income tax. The bizarre rules means people have in some cases paid thousands of pounds too much in tax.
Assuming no other income, a £10,000 withdrawal should be tax free because it falls under the personal allowance (£11,500 in 2017-18). But if HMRC applies emergency tax the bill would be over £3,000.
Income tax has worked on this basis for decades but the “month one” problem has been exposed by the “pension freedoms”. These reforms, introduced in 2015, mean over-55s are free to take irregular withdrawals from their pensions whenever they like.
But financial advisers have realised that by making a small initial withdrawal you can avoid being caught out.