Emergency tax and reclaims
Following the introduction of the Pension Freedoms rules, measures were put in place to prevent clients from withdrawing their entire fund and avoiding sufficient income tax. Before Pension Freedoms, income was limited, and the PAYE system would gradually recover underpaid tax. However, this isn’t feasible if the entire fund is accessed at once.
To address this, an emergency tax code is used for those without a valid and unused P45 for the relevant tax year. Initially, this code is applied on a month 1 basis until HMRC can review the payment and issue the correct code to the pension provider.
What does this mean for clients?
It doesn’t matter what other income the client has for this first payment or when in the year it is paid, the emergency tax code on a month 1 basis is the same.
| Gross income payment | £10,000 |
| Gross income payment £10,000 Less 1/12 of full personal allowance | £1,048 |
| Taxable income | £8,952 |
| Tax | |
| 20% on £3,142 (1/12 of basic rate band) | £628 |
| 40% on £5,810 (remainder in higher rate band) | £2,324 |
| Total tax payable | £2,952 |
| Net income payment | £7,048 |
If the individual was going to take £10,000 each month, had a full personal allowance and this all started in April then this tax would be correct. But at that level of income they wouldn’t have a full personal allowance so even then we aren’t looking at the correct outcome and the tax paid over the year wouldn’t be enough. If this is their only payment and the individual has no other income, then this would be an overpayment of tax of £2,952, which would need to be claimed back.
In the long run, the key consideration is the amount of tax that should have been paid and whether any of it needs to be reclaimed.
Example 1 – no other income
If this is their only income for the year, it would fall within their Personal Allowance and as such no tax would be due. So, they would have overpaid £2,952.
Example 2 – income from other sources in excess of the basic rate band
As their personal allowance and basic rate band are used on other sources of income, all this £10,000 should have been taxed at 40% (£4000), meaning that they have, in fact, not paid sufficient tax. As they have other sources of income, this tax will either be reclaimed via an adjustment to their tax code the following tax year or paid via self-assessment, if applicable.
Example 3 – Regular income
If, in the above example the client takes a regular income, HMRC will, in time (usually by the next pay date, but not guaranteed), send the pension provider an updated cumulative tax code. This means that over the remainder of the tax year the correct tax will be collected and no tax reclaim, or additional tax payment, would be required.
Reclaiming any overpaid tax
If the individual doesn’t take regular income, then it may be worthwhile reclaiming the extra tax paid during the tax year. This is possible even if the funds within the scheme have not been exhausted. It is important to note that depending on the client’s circumstances different forms are required, with different evidence.
To reclaim tax within the same tax year the following forms should be used.
- P55 to reclaim an overpayment of tax when funds have been flexibly accessed but the fund has not been extinguished.
- P53 to reclaim an overpayment of tax on a trivial commutation lump sum or small pension pot taken as a lump sum.
- P50Z to reclaim an overpayment of tax when funds have been flexibly accessed and the fund extinguished, and the individual has also ceased to work or claim benefits.
- P53Z to reclaim an overpayment of tax when funds have been flexibly accessed and the fund extinguished.
Alternatively, if none of the above are completed HMRC will reconcile the tax paid at the end of the year and will provide a refund or amended tax code in the following tax year. This is the least hassle but will mean a significant delay in the refund.
Conclusions
There is no way to avoid this scenario. Even with a P45, the month 1 application will usually mean the initial taxation of any income is incorrect. It is important to understand the requirements of the client – it may be that a larger amount of income is needed if the funds are required immediately, and the client can’t wait for a reclaim or for the tax code to be adjusted. This will however mean that the client will end up with less in their pension as a result and they may just spend the reclaim when it arrives.
This information is for UK financial adviser use only and should not be distributed to or relied upon by any other person.
Every care has been taken to ensure that this information is correct and in accordance with our understanding of the law and HM Revenue & Customs practice, which may change. However, independent confirmation should be obtained before acting or refraining from acting in reliance upon the information given.
References
1 ‘Systemic risks: A framework for portfolio resilience’, UKSIF, Scottish Widows, Canbury, May 2025. Systemic-risks-a-framework-for-portfolio-resilience.pdf
2 ‘The Global Risks Report 2025’, World Economic Forum, January 2025. WEF_Global_Risks_Report_2025.pdf
3 Systemic Risk Survey Results – 2024 H2, 2 October 2024, Bank of England, Systemic Risk Survey Results – 2024 H2 | Bank of England
