Hundreds of thousands of pensioners are being urged to consider a simple £1 financial manoeuvre to sidestep a costly and bureaucratic tax trap. The call to action follows revelations that over-55s have been forced to claw back a staggering £44 million in overpaid tax on their pension withdrawals.
The Scale of the Emergency Tax Problem
Official figures obtained by the Labour Party show that more than 15,000 pension savers submitted claims to HM Revenue and Customs (HMRC) to get their money back. The average sum reclaimed was a substantial £2,881. A Freedom of Information request by insurer Royal London uncovered that in the 2022-23 tax year alone, there were 2,300 claims each worth over £10,000.
The root of the issue lies in the way HMRC handles a person's first flexible withdrawal from their pension pot. While 25% of a pension can usually be taken tax-free, the remaining 75% is taxed as income. The problem arises because HMRC frequently lacks an accurate, up-to-date tax code for the individual at the point of that first withdrawal.
How the £1 'Pension Trick' Works
Personal finance experts are now advocating a proactive strategy known informally as the "£1 HMRC pension trick." The method is straightforward: before taking a significant lump sum, make a tiny, nominal withdrawal of as little as £1.
"The £1 pension trick is a clever strategy some people use to avoid that first-time emergency tax hit," explains Aaron Peake, a personal finance expert at CredAbility. "You take out just £1 from your pension pot before making your actual lump sum withdrawal. That initial small withdrawal sets a tax code on your record, which means when you take the proper amount out afterwards, the provider applies a more accurate tax code, and you avoid being overtaxed."
David Gibb, a chartered financial planner at Quilter Cheviot, clarifies why the emergency tax is applied in the first place. "When someone makes their first flexible pension withdrawal, HMRC may apply emergency tax, assuming it’s a monthly payment rather than a one-off lump sum. This happens because HMRC doesn’t yet have an up-to-date tax code for the individual’s pension provider."
The Hassle of Reclaiming Your Own Money
Helen Morrissey, pensions and retirement spokesman at Hargreaves Lansdown, details the financial impact. "When you’re taxed on an emergency basis you’re treated as though the same amount will be taken on a monthly basis. As a result, the income tax payment is calculated using a twelfth of your personal allowance and tax bands. The remainder will be taxed at additional tax rates, so they are paying tax at much higher rates than they ordinarily would."
She warns that the sudden shortfall can cause significant disruption. "The excess tax can be reclaimed by filling out a form, but being taxed in this way can take a significant chunk out of the money you were expecting to receive, which could cause you financial hardship or mean you have to change your plans."
Tom Selby, director of public policy at AJ Bell, has criticised the system as "outdated." While the £1 trick is widely recommended, David Gibb adds a note of caution. "While this trick can work well, it’s not 100 per cent foolproof, and some individuals may still need to submit a tax reclaim form (P55, P53 or P50Z) to HMRC if excess tax is deducted. Nevertheless, it can significantly reduce the hassle of reclaiming large amounts later."
The advice is clear for anyone approaching retirement and considering accessing their pension flexibly: a tiny, strategic withdrawal first could prevent a major financial headache and ensure you receive the full amount you are entitled to from the outset.
