The UK's tax authority, HMRC, is facing renewed criticism after new data reveals it continues to overtax tens of thousands of state pensioners when they access their own savings. A system flaw, unresolved since the introduction of Pension Freedom rules a decade ago, has led to the taxman repaying a staggering more than £1.5 billion to those who were incorrectly charged.
The Scale of the Problem
In the third quarter of 2025 alone, 13,721 pension savers were forced to submit claims to reclaim overpaid tax on their pension withdrawals. This figure represents an 11 per cent increase compared to the same period last year. The total amount repaid in this three-month window reached £48.5 million, pushing the total sum returned to overtaxed individuals past the £1.5 billion mark for the first time.
A 'Fundamental Flaw' in the System
Experts point to a critical weakness in how HMRC handles one-off pension withdrawals. While the government improved its tax code process in April 2025 to help people in drawdown move to the correct tax code more quickly, this change offers no relief for those making a single, lump-sum withdrawal.
Investment platform AJ Bell describes this as one of the “fundamental flaws” with the current system. Tom Selby, Director of Public Policy at AJ Bell, states: “HMRC is still yet to address one of the longstanding flaws in its approach to taxing those who choose to flexibly access their hard-earned pension pots.” He warns that the official repayment figures are likely just “the tip of the iceberg”, as they only include people who proactively filled out a reclaim form, with many others waiting for HMRC to correct their tax at the end of the year.
Broader Consequences for Retirees
Jon Greer, Head of Retirement Policy at Quilter, adds that it remains “extraordinary” that the issue persists a decade after pension freedoms were launched. He explains that the PAYE system was designed for regular employment income, not one-off pension withdrawals, creating unnecessary complexity for retirees.
The problem is compounded by the rising state pension and the frozen personal tax allowance, which are dragging more people into the tax net. When these individuals make a flexible withdrawal, a larger portion is taxable, making an over-taxation even more frustrating. Greer also notes that current budget uncertainty is prompting some to make hasty pension decisions, potentially damaging long-term financial plans.
