Emergency tax codes could be adding thousands onto tax bills for people withdrawing their pensions, but taking just £1 out first could cut this down drastically according to experts
People taking money from their pensions frequently face taxation under emergency tax codes because of how the pension tax system operates. This can result in people paying thousands of pounds more in tax than necessary – although this money isn’t lost forever as it can be reclaimed from HMRC through a tax rebate.
But savers might be able to prevent overpaying tax initially by being tactical with their first taxable pension withdrawals. The initial 25 per cent of your pension is distributed tax-free, after which HMRC applies a tax code at the highest rate for which you’re eligible.
This is where the £1 technique becomes relevant. Clare Moffat, pensions expert at Royal London told the Telegraph: “How much you would need to take out would depend on your provider, so you need to check with them first. But even if you can’t take £1 out, taking out £100 may still be enough to generate a tax code from HMRC that the provider can apply.”
After this tax code is created, there’s still no guarantee that HMRC will accurately work out the appropriate income tax on the pension income. But the likelihood of requiring a substantial refund at the tax year’s end becomes significantly reduced.
This occurs due to HMRC’s method of calculating tax on pension income. It uses what’s known as the “month one” calculation, examining a person’s initial month of income to work out how much tax they could owe throughout the entire tax year.
The issue with this is that it results in the tax authority applying only one-twelfth of a person’s annual tax-free allowances to the calculation, and doesn’t account for variable income, which flexible pension withdrawals often are.
If you consistently withdraw similar amounts from your pension each month, the first month’s calculation can accurately reflect your income for the year.
However, if you withdraw a large lump sum from your pension to use throughout the year, HMRC assumes you’re receiving this high amount every month and taxes you accordingly for the entire year.
Between April 1 and June 30 this year, HMRC refunded approximately £48.7 million across nearly 13,000 refund forms, with the average person receiving £3,800.
If you end up paying more tax on your pension income than necessary, there are several ways to claim a refund.
The government’s website provides a free checker tool to determine if you might be due a refund and how best to claim it.
In April this year, HMRC introduced new processes to simplify this taxation issue by automatically updating tax codes for individuals newly receiving a private pension.
However, since this change was implemented, the amount paid out in refunds has actually increased by more than £4 million compared to the three months from January to March 2025.