Brits drawing their pensions are being warned not to hand over thousands of pounds unnecessarily to the taxman – and experts say there’s a simple £1 trick that could prevent it.
When savers over 55 take money from their pension for the first time, HMRC often applies an ‘emergency tax code’ that treats the withdrawal as if it were a monthly income for the rest of the tax year – resulting in a hefty overpayment.
HMRC data show that nearly £50 million was refunded to savers in 2024 who had been taxed too much on their pension withdrawals.
According to the Government: “If you take a lump sum payment from your pension, you might be put on an emergency tax code. This means you could pay too much tax until HMRC updates your code.”
Financial experts say there’s a way to avoid the overpayment trap – by taking a token £1 or £10 withdrawal first, to prompt HMRC to issue the correct tax code before taking the full sum.
Pension specialists at Royal London explain: “If you take a large withdrawal from your pension for the first time, it may be taxed using an emergency tax code which can result in too much tax being deducted. One way to avoid this is to take a small withdrawal first, to trigger the correct tax code.”
Similarly, tax advisers at THP Chartered Accountants warn that the emergency tax system “often catches people out”.
They said: “The tax deducted is calculated as if the amount withdrawn will be paid again every month for the remainder of the tax year. This can lead to a significant overpayment.
“Taking a smaller initial withdrawal allows HMRC to send an updated code to your pension provider before you take the larger amount.”
Helen Morrissey from Hargreaves Lansdown said: « Someone withdrawing £20,000 could face an emergency tax bill of £7,379 when they should only pay £1,484 as a basic-rate taxpayer. »
That leaves nearly £6,000 of someone’s own money held in limbo until the HMRC processes a refund.
PensionBee said the issue stems from HMRC’s default treatment of flexible pension withdrawals.
It said: “HMRC requires providers to use an emergency tax code for the first withdrawal, assuming it will be repeated monthly. The result is that you pay more tax than you owe and have to claim it back.”
How to reclaim if you’ve already been hit
Those who have already overpaid can get their money back — but must apply directly to HMRC using one of three forms, depending on the circumstances.
According to gov.uk guidance: “You can reclaim tax using forms P55, P53Z or P50Z if you’ve withdrawn money from your pension and paid too much tax.”
Refunds can take several weeks, but PensionBee says most are completed within a month, saying: “HMRC usually refunds emergency tax within 30 days of receiving the claim.”
How to protect yourself
1. Withdraw £1 or £10 first – This triggers HMRC to issue the right tax code
2. Wait for your provider to apply the new code – This prevents the emergency rate
3. Take your full lump sum – Tax is deducted correctly
4. If you’ve overpaid, fill in form P55 or P53Z – HMRC refunds within weeks
Experts warn, however, that any withdrawal from a defined contribution pension can trigger the Money Purchase Annual Allowance (MPAA), cutting future tax-relieved contributions to £10,000 a year.
Financial advisers say taking a small “starter” withdrawal can be a simple way to avoid months of paperwork and waiting for refunds.
As Royal London’s guidance puts it: “A small first withdrawal can save time, money and hassle – and stop HMRC holding on to more of your cash than it should.”
