A 71-year-old pensioner who had £7,787.25 deducted from a £20,000 pension withdrawal has been told the tax treatment was likely correct, but a significant refund is probable. The reader, who took the money to fund Junior ISAs for grandchildren, questioned whether their provider applied the right tax code.
Tax code applied correctly
Josh Croft, senior technical consultant at AJ Bell, said the figures suggest the provider applied the tax code they were given correctly. The reader first withdrew £1,000 in December 2025, then £20,000 in March 2026, with HMRC issuing a tax code of 166L in between.
The £20,000 payment was taxed on a non-cumulative, or 'Month 1', basis. This meant the provider could not look at the reader's income for the whole tax year. Instead, the payment was treated as though it were a normal monthly payment, giving only one month's share of the tax-free allowance and tax bands. As a result, part of the withdrawal was taxed at 20%, part at 40% and part at 45%.
Common frustration with flexible withdrawals
Croft said it is not necessarily the case that the provider made a mistake, but rather the way the tax rules operate. PAYE is designed around regular income, so a large one-off pension payment can temporarily be pushed into higher or additional-rate tax, even where the individual's actual annual income is much lower.
The 166L tax code meant HMRC was only giving around £1,660 of tax-free allowance against the pension. Part of the reason is likely to be the State Pension, which is taxable but not normally taxed directly, so HMRC often reduces the tax-free allowance available against another pension or salary instead.
Refund likely
Based on the figures provided, the reader's total income for the year was around £31,000, so most or all of the taxable amount should fall within the basic-rate band. Croft said this suggests several thousand pounds were overpaid.
Because the payment was taken in the 2025/26 tax year, which has ended, HMRC will deal with the overpayment differently rather than through an in-year P55 claim. The reader should ask HMRC to review their final tax position for 2025/26, or use their Self Assessment return if they complete one.
Croft added that taking pension income earlier in the tax year in future could allow the use of form P55 to reclaim tax during the relevant tax year, rather than waiting for resolution the following year. This would help ensure any overpaid tax is recovered as quickly as possible and allow the grandchildren's Junior ISA allowance to be used in that tax year.
