Why am I paying emergency tax on my pension withdrawal?

If you have taken money from a pension and the tax taken off looks far too high, you are almost certainly on an emergency tax code. Pension providers typically use temporary or emergency tax codes when you take your first lump sum, and the result is that more tax is taken than should be¹. It is a timing problem, not a mistake in your pension.

The reason is the basis on which the first payment is taxed. If your provider does not hold your tax code and details of your other income, withdrawals are taxed using a higher-rate emergency tax code, calculated on what is known as a "Month 1" basis². A £10,000 withdrawal could result in you being taxed as though your annual income is £120,000². The overpaid tax is normally refunded, but you usually have to wait or claim.

This page explains why the first withdrawal is taxed this way, which withdrawals are most likely to be hit, how the overpayment comes back to you, and the situations where the final bill turns out to be higher rather than lower.

Why your first pension withdrawal is taxed on an emergency code

Pension saving works on an "exempt, exempt, taxed" model for income tax: nothing is taxed on the way in or while it grows, and tax is paid when money comes out⁶. When you get money from a pension you pay tax on any income above your tax-free Personal Allowance⁷. The difficulty is that a pension is not a salary, and HMRC does not automatically know what your income for the year will be.

If you take a large one-off withdrawal from a pension, your provider may apply an emergency tax code, which can result in too much tax being taken². Money taken using the pension flexibility rules is often taxed using an emergency tax code for the same reason⁸. When you first receive your pension, sometimes a tax code is not issued in time and an emergency tax code is used, which means more tax is likely to be taken than should be⁹.

It helps to know who does what. HMRC applies emergency tax codes, and it may apply one if it does not have enough details about how much tax you need to pay⁵. Your employer or pension provider then uses the code it has been given¹⁰. Providers are required by HMRC to deduct emergency income tax from certain payments, and they apply an emergency rate until they receive your individual tax code from HMRC directly¹¹.

Emergency codes are not unique to pensions. The most common time to find you have been put on one is when you have just started working for a new employer⁵. The pension version feels sharper because a single withdrawal can be large.

How the "Month 1" basis leads to too much tax being taken

The emergency code is not the whole story. The damage comes from the basis on which the code is applied. Withdrawals are charged tax at an emergency rate on the assumption that the amount will be withdrawn monthly, which causes many people to overpay tax¹³. In other words, the system treats one payment as if it were the first of twelve identical payments across the year.

That assumption is what produces the startling figures. A £10,000 withdrawal could result in you being taxed as though your annual income is £120,000². The tax taken is calculated on what is known as a "Month 1" basis when the provider lacks your tax code and other income details². If the provider does not have that information, you may be charged a "Month 1" tax, or an emergency tax, which can be quite high¹⁴.

The first lump sum you take from your pension often will not be taxed correctly by HMRC, meaning you might initially pay more tax than you need to¹⁵. When you first take a taxable income, you may be assigned a "Month 1" emergency tax code, which could result in a tax overpayment claimable from HMRC¹⁶.

The amount of tax you actually owe depends on the amount of payments you receive in the tax year plus any other taxable income¹⁷. The emergency basis ignores that for the first payment and settles up later.

Which withdrawals are most likely to be hit

The pattern is consistent across providers: the first taxable payment from a pot, made without a tax code on file, is the one that attracts the emergency treatment. When you take your first withdrawal, you will probably be taxed using an emergency tax code, and that could mean you overpay¹⁸. The same wording appears in provider material: when you take your first withdrawal, you will probably be taxed on an emergency tax code¹⁹.

Beyond the first payment, the risk depends on how you take the money. Usually, any income you withdraw from your pension is subject to tax¹⁵. Any withdrawals you make beyond the 25% tax-free share are subject to income tax²⁰. Anything over 25% is subject to income tax and could potentially push you into a higher tax bracket¹⁵.

Some routes carry an explicit warning. Emergency tax may be deducted on a UFPLS payment, requiring a reclaim from HMRC²¹. For encashment payments, a provider will deduct emergency tax which could be higher than your liability to tax, and you then need to contact HMRC²². A drawdown calculator may apply an emergency "Month 1" tax code, giving you only one twelfth of the available allowances in accordance with HMRC guidelines²³.

The withdrawals least likely to cause a problem are regular income payments where the provider already holds a correct code, because the code can be applied properly from the start.

Large one-off withdrawals and cashing in a whole pot

The bigger the single withdrawal, the more visible the emergency treatment becomes. There may be high tax charges because only 25% of each withdrawal, or of your lump sum, is tax-free, and the remainder is taxable³. You can take 25% of your pension pot tax free in one go, meaning any more money you take out will be taxed as income²⁴. Alternatively you can take 25% of every cash withdrawal tax free, with the remaining 75% taxable as income²⁴.

Cashing in the whole pot concentrates all of this into one payment. When you take a lump sum from your pension, 25% is usually paid tax-free, as long as the total amount of tax-free cash taken stays within the limit, and the other 75% counts as earnings for Income Tax⁸. The first 25% of your pension will be tax-free, but you will then pay tax on the rest in the same way as other income²⁵. When you cash in your pension, you can usually take up to 25% of your money tax free, but the rest may have a tax charge²⁶.

On top of the underlying liability, you are also likely to pay tax at an emergency rate, which you will need to claim back from HMRC through a tax return²⁶. HMRC requires providers to take tax at the emergency rate from the payment and pay it over²⁷. A retirement calculator may assume that the tax payable on the remaining pension fund uses the emergency tax rate, with overpaid tax reclaimable from HMRC²⁸.

Emergency tax usually corrects itself on later payments

An emergency code is a temporary measure⁵. It is only temporary and will switch to the right code as soon as HMRC has all the right tax information²⁹. Once HMRC has all the information to set you on the right tax code, you will be refunded any tax that you have overpaid²⁹.

For people taking a regular income, that often means the position resolves without a separate claim. You will be able to claim the money back from HMRC directly, or, if taking regular income, this will correct itself once HMRC provides an up-to-date tax code¹⁴. For income payments, HMRC is able to issue your pension provider with a fresh tax code for future payments to offset the overpayment³⁰.

There is a limit to how automatic this is. A provider will always apply an emergency tax rate on withdrawals until it receives your tax code from HMRC directly²³. So the correction depends on the code reaching the provider, not just on HMRC knowing.

If you are not in an urgent hurry, you can wait until the end of the tax year and a refund can be applied through your tax return³⁰. If you have emptied your pot or do not plan further withdrawals soon, that route is often the simplest.

Getting an overpayment back from HMRC

If your emergency tax code means you have paid too much tax, HMRC will send you a tax rebate⁵. The timing is the part people ask about most. HMRC will eventually refund the overpaid tax, usually at the end of the tax year, but you can get your money back within 30 days by submitting the relevant form⁴.

There is a rule about claiming mid-year. In most cases, you cannot claim a refund during the tax year unless you are only making a single withdrawal for that year⁸. HMRC will check everything at the end of the tax year as part of its reconciliation process and send you a P800 if a refund is due⁸.

If you complete a Self Assessment tax return, the route is different. You will usually need to wait until the end of the tax year to sort everything out through your return, and you must still include the pension withdrawal and any claim in your tax return even if you reclaimed some tax earlier⁸. If you are on Simple Assessment and you pay too much, you need to contact HMRC for a refund³¹.

A few practical points are worth knowing. Your provider may offer a cooling-off period, often 30 days, allowing you to reverse the withdrawal, though eligibility depends on when and how you accessed your tax-free cash³². And if you are consolidating or moving pots, some pensions charge exit fees, which could wipe out any savings from switching, so check the details before making a move³¹.

When you might owe more tax, not less

An emergency code usually means too much tax has been taken, but not always. HMRC might apply an emergency tax code when you take your savings, and if your final tax owed is lower than what you have already paid, you will receive a refund; if it is higher, you will get an additional bill²⁶.

Several things can push the final figure up. All pension drawdown income is counted when calculating how much Income Tax you will pay each tax year, which runs from 6 April to 5 April, apart from the upfront lump sum worth up to 25% and 25% of other lump sums within limits³³. You pay income tax if your total annual income, including any pensions, adds up to more than your Personal Allowance³⁴. You will only pay tax if your total taxable income, including your State Pension, is higher than your personal allowances³⁵.

The State Pension can be the reason a pension withdrawal tips into tax. If the State Pension exceeds the Personal Allowance, HMRC takes additional tax from your occupational pension to cover tax owed on the surplus State Pension³⁶. It will usually change your tax code so the tax due is collected from your wages or other pensions³⁵.

There is also a separate charge to be aware of if you are still paying in. If your pension savings are more than your annual allowance for the tax year, and you do not have unused annual allowances from the three previous tax years to cover the difference, you have to pay tax³⁷. That is a different charge from the emergency code on a withdrawal, but it can arrive in the same year.

If you are taking money from your pension fund early, it can have a big effect on your financial future, you may have to pay tax on some of the money you take, and your benefits entitlement could change now and in the future³⁸. Free, impartial guidance on your options is available from Pension Wise, and general information on personal pensions is available from MoneyHelper.