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Pension savers reclaimed a total of £44 million in overpaid tax on pension withdrawals between January and March this year, according to the latest government figures. More than 15,000 people reclaimed an average of £2,881 after they were taxed at an emergency rate, rather than their normal rate when making a withdrawal.
It means that since 2015, total repayments for overtaxed pension withdrawals have exceeded £1.4 billion. But by using what’s become known as the “£1 pension trick,” you may be able to avoid the headache of a large emergency tax charge in the first place.
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The introduction of pension freedoms in 2015 mean that you can now flexibly withdraw money from your pension when you reach the age of 55 (rising to 57 in April 2028). Rachel Vahey, Head of Public Policy at AJ Bell, says: “One of the advantages of pensions freedoms is the complete flexibility it gives you to take money out of your pension at the right level, at the right time, to completely meet your needs in retirement.”
You can usually take 25% of your pension pot tax-free, but the remaining 75% will be treated like other income and subject to tax. The problem is when you first make a flexible withdrawal from your pension (not your tax-free lump sum), HMRC doesn’t always have an accurate tax code for you. As a result, it will often apply an emergency tax rate, meaning your initial withdrawal can be taxed far more than necessary.
David Gibb, chartered financial planner at Quilter Cheviot, says: “While excess tax is later reclaimable, it can take weeks or months to recover – causing frustration for retirees who need immediate access to their funds.”
Emergency tax is a temporary tax code used by HMRC when it doesn’t have enough information about your income or tax situation to apply the correct income tax code right away. HMRC will later update your tax code to make sure you pay the correct amount of tax over the course of the year.
When emergency tax is applied, HMRC assumes that the payment you’ve received is recurring monthly income, not a one-off lump sum, and this pushes you into a higher tax bracket than you might actually fall into.
Helen Morrissey, head of retirement analysis at Hargreaves Lansdown, explains: “This is because the income tax payment is calculated using one twelfth of your personal allowance, one twelfth of your basic rate tax allowance and one twelfth of your higher rate allowance. The remainder will be taxed at additional tax rates so you are paying tax at much higher rates than you ordinarily would.”
She adds: “As an example, if you paid emergency tax on a £20,000 drawdown withdrawal you could pay £7,379 income tax on it. This compares to the £1,484 that you would otherwise pay.”
One way to avoid the shock of an emergency tax bill is to make a small, notional withdrawal first, with experts suggesting this could be as little as £1. “The £1 pension trick is a clever strategy some people use to avoid that first-time emergency tax hit,” says Aaron Peake, 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.”
However, while it’s a smart idea in theory, not all pension providers will allow it. “Some have minimum withdrawal amounts or admin fees that make it impractical, so it’s worth checking with your scheme before relying on this approach,” adds Peake. You might also need to submit a paper request if you wish to withdraw such a small amount (rather than withdrawing online).
If you can’t withdraw as little as £1, withdrawing £50 or £100 could still generate a tax code from HMRC and solve the problem before you take a larger sum. However, be warned that in some cases, emergency tax may still be applied (you’ll just a lot pay less on a small sum) and you’ll still need to submit a claim to get the excess tax refunded.
As well as checking the terms and conditions of your pension scheme, there are other factors that need to be considered before making a taxable withdrawal from your pot. Morrissey says: “You need to be aware that if you have accessed your pension flexibility then you are subject to the Money Purchase Annual Allowance.”
This means you can only contribute up to £10,000 a year to your pension and receive tax relief, rather than the pension allowance, which is 100% of your income up to £60,000 a year for most people. “It’s important to consider this if you are still planning to contribute to your pension,” she adds.
Remember, too, that withdrawing cash from your pension will reduce the amount you have to live off in retirement, so it’s sensible to get advice first.
Despite this, more than a quarter of UK adults aged 50 or over have not sought guidance before accessing their pensions, according to Legal & General, leaving them exposed to unexpected tax bills or losing entitlement to means-tested benefits. According to the research, 46% of those who accessed their pension did so just “because they could”, while 32% did so to cover essential expenses.
Those approaching retirement should carefully consider how they want to use their 25% tax-free lump sum to avoid paying unnecessary tax. Tax-free lump sums can be taken in one go or in stages, either when you buy an annuity or move into drawdown. As these payments aren’t taxable, emergency tax won’t be applied.
“Taking it all at once might not always be the most effective strategy for managing taxable income effectively, as it can push subsequent pension withdrawals into higher tax bands,” says Gibb. By withdrawing only what you need each year, you can plan withdrawals so that you stay within a lower tax bracket.
Earlier this year, HMRC announced that from April 2025 it was taking steps to fix the emergency tax pension problem. The tax office will now move more quickly to replace the emergency tax codes applied to pension withdrawals with regular tax codes.
This should mean the correct amount of tax is deducted. However, the changes are more likely to benefit those who make regular pension withdrawals, as HMRC should adjust your tax code so that over the course of the year you are taxed the right amount.
If you’re making a single ad-hoc withdrawal from your pension, you are still likely to be overtaxed and may need to reclaim the excess. The claims process can usually be completed online. You’ll need to fill in a form P55, P53Z or P50Z, depending on how you accessed your pension and your employment and benefit situation.
In most cases, you should get the money back within 30 days. Alternatively, you can print off claim forms and post them to HMRC if you prefer.
While HMRC’s April 2025 system changes aim to make pension taxation smoother, especially for regular income, the issue of potential emergency tax on initial lump-sum withdrawals persists.
The £1 pension trick can still be a useful tactic to consider to prompt a more accurate tax code before taking a larger taxable sum. Before accessing your pension, always check the specific rules with your provider, understand the tax implications (including the MPAA), and consider seeking independent financial advice to ensure your decisions align with your overall retirement plan.
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