Emergency tax on pensions

As soon as you turn 55 (rising to 57 in 2028), it’s possible to start taking money out of your pension.

However, if you plan to withdraw a lump sum, it’s important to understand how this payment will be taxed and that you may be forced to pay emergency tax.

How pension lump sum withdrawals are taxed

You can usually take the first 25% of your pension as tax-free cash (up to a maximum of £268,275).

However, there are two ways you might take a lump sum out of your pension.

The first is by a process called UFPLS (uncrystallised funds pension lump sum). This is when you take a lump sum out of your pension without then moving it into drawdown or buying an annuity (what is known as crystalising your pension). Only the first 25% will be paid tax free.

The remaining 75% of your withdrawal will be added to your overall income for the year and taxed at your marginal rate of income tax. 

The second way happens when you have already taken your 25% tax-free cash and moved into flexi-access drawdown. In these cases, any withdrawal will be added to your income for the year and taxed at your marginal rate.

Problems with emergency tax can potentially apply with each type of lump sum withdrawal.

Why might I have to pay emergency tax on my pension lump sum?

Problems arise with pension lump sum withdrawals because your pension provider is unlikely to know what your overall income is, or have an up-to-date tax code.

This means that when you make your first taxable withdrawal with a provider, it cannot properly work out how much tax to deduct and has to charge emergency tax. This is in accordance with HMRC rules and guidelines.

How is emergency tax on pension lump sums calculated?

Even though your withdrawal may well be a one-off, an emergency tax code will assume that it is the first of a series of monthly payments.

This is known as being taxed on a ‘Month 1’ or M1 basis. To calculate it your pension provider will take 1/12 of each of the tax bands: basic, higher and additional rate.

This will mean that the vast majority of people will end up paying more tax than is necessary. Only additional rate taxpayers are likely to underpay when emergency tax is charged.

For the 2024/25 tax year, the emergency tax code is 1257L (M1) – it will mean you get a tax-free sum of £1,047.50 and anything over that will be taxed.

Any tax you overpay can be reclaimed through HMRC. But, if you need a specific amount of money and cannot wait for a refund, you will need to allow for emergency tax when you make your withdrawal.

Emergency tax: an example

Catherine has a final salary pension which pays her an income of £20,000 a year. However, she also has a SIPP which she can draw on for additional expenses – she’s already taken her 25% tax free cash to pay off her mortgage.

Catherine has decided to take a last-minute trip to see her grandchildren in Australia and wants to withdraw a lump sum of £18,000 from her SIPP to pay for it. 

However, if she wants to travel any time soon, the tax payable on her withdrawal will mean she actually needs to take close to £30,000 out.

This is how is how the tax is calculated using the tax code 1257L M1:

*Based on UK income tax rates and bands (except Scotland). Source: abrdn

Claiming back emergency tax on pension lump sums

As frustrating as emergency tax is, you should get any money you have overpaid back. Note – this isn’t a refund of all the tax you paid on your withdrawal, just the amount over and above what was owed based on your own rate of income tax.

For income payments, HMRC is able to issue your pension provider with a fresh tax code for future payments to offset the overpayment.

However, this won’t be an option if you have emptied your pot or don’t plan to make any further withdrawals for a while.

In this case you have a choice. If you aren’t in an urgent hurry you can wait until the end of the tax year and a refund can be applied through your tax return. How long you need to wait will depend on how close your withdrawal is to the end of the tax year.

If you don’t want to wait – which may well be the case if you’re owed a substantial amount - you will need to complete a repayment form from HMRC to arrange a refund before the end of the tax year.

Which form do I need to reclaim emergency tax on a pension lump sum?

HMRC has several forms you can use to claim a refund for emergency tax paid on a pension.

Which one is right for you will depend on your circumstances.

• P50Z – should be used if you if cashed in your whole pension and have no other sources of income.
• P53Z – should be used if you have cashed in your whole pension but also have other sources of income.
• P55 – should be used if you have only taken part of your pot as cash and have no immediate plans to make any further withdrawals.

Refunds from HMRC are usually paid within 30 days.

If you plan to make further withdrawals from your pot, HMRC will supply your pension provider with a new tax code that reflects the tax overpayment that you have made.

What can I do to stop paying emergency tax on my pension lump sum?

Whether or not you have to pay emergency tax on your pension lump sum will often be out of your control.

However, if you plan ahead, there might be some steps you can take to mitigate it.

• You might be able to prevent emergency tax being charged if you can make sure your pension provider has an up-to-date tax code for you. 
• Another option to avoid a big emergency tax bill, is to make a token withdrawal, before making a larger one. You might have to pay a smaller amount of emergency tax on the first withdrawal, but by the time you make the big one, HMRC should have issued an up-to-date tax code for you. This means that you should pay the appropriate amount of income tax on it.