How does emergency tax work ?

MetaPhysical

Sanity check please on how this works?

So say I retire and I decide to take my first year's UFPLS payment early in the new tax year, with maybe another payment in October.  So something like this:

7th April £15k
7th October £15k

Ignoring TFC for this discussion.   Surely HMRC systems don't say to themselves "Ah, he took £15k on April 7th so his salary must be 12 x 15000 = 180k so we'll tax him 45% on that second payment" ???????  Surely in this AI era some common sense prevails and they'd know that I couldn't be on such a high salary having known my tax history for the last 42 years????

MetaPhysical

^^^^^ I also get £2500 per month from my DB as well.  So will they actually think "we'll take 45% of each monthly payment as well?"   - when it should be 20%.

DRS1

Some experts will be along but it is usually the first payment people worry about with emergency codes.  By the time the second comes along you will have a tax code for the pension.

horsewithnoname

Emergency tax codes are codes that operate on a week or month one basis, ie each month is treated in isolation and taxed giving one months worth whatever allowances and rates are given in the code against the income for that one month. This is different to a cumulative code which in effect adds together the month in question and all previous months and gives the proportion of the allowances and rates at that particular point. 

So for example in month 4 of the tax year the effect would be as if your four months pay were added together and four twelfths of your allowances and rates at that bands were allocated to that, so if you’d had high income in the first three months then very little or none in month four, you’d pay no, little or get a refund of tax. 

On emergency code in the same example, in month four you’d pay little or no tax, but not get a refund of the previous months, because they are all treated in isolation and; as if they were all month one. 

An emergency code is generally if a P45 is not given to the new employer, often because the existing source is ongoing. 

AI is certainly not that clever, and it is barely used in the public service at present, though doubtless it may be at some point. 

eastcorkram

MetaPhysical said:

Sanity check please on how this works?

So say I retire and I decide to take my first year's UFPLS payment early in the new tax year, with maybe another payment in October.  So something like this:

7th April £15k
7th October £15k

Ignoring TFC for this discussion.   Surely HMRC systems don't say to themselves "Ah, he took £15k on April 7th so his salary must be 12 x 15000 = 180k so we'll tax him 45% on that second payment" ???????  Surely in this AI era some common sense prevails and they'd know that I couldn't be on such a high salary having known my tax history for the last 42 years????

Can you not just divide what you want each year by 12, and draw it monthly?

Linton

PAYE allocates 1/12 of the total tax codes and bands each month and calculates the tax due on the income received that month. Normally these accumulate over the year.

Normal situations
-----------------------
 For example:
In April with a standard 1257L tax code and £60K annual= £5K monthly income you get £12570/12 tax free, £52570/12 -£12570/12 taxed at 20% anfd the rest taxed at 40%. 

In May your accumulated income has risen to £10K and your accumulated tax allowance and bands are now 1/6th the annual values so taking into account the tax already paid you have the same tax again to pay again.

This works fine for people with a steady, possibly increasing, income. 

One-off income
---------------------
For one-off payments,(eg bonuses, lump sum drawdown) it works less well.  You have a single month with a high income but the the accumulated tax bands are only increased by 1/12 the annual values. So you are charged excess tax.  However the following month without the one-off income but with excess tax already paid you will get charged less tax.  So the situation will resolve itself pretty quickly assuming you do continue to get steady income.

New starters
-----------------
If someone new starts receiving income HMRC has no prior knowledge and so cannot issue a tax code appropriate to the circumstances.  Without a tax code, the "employer" must use an emergency one.  This I believe is usually 1257X.  The X (otherwise known as M1) forces PAYE to work as if the current month is April.  There is no accumulation.  By the next month or so HMRC should have issued a specific tax code with cumulation which will correct any errors arising from the emergency tax code being inappropriate.

Initial taxable pension lump sums
--------------------------------------------
These give rise  to 2 problems - both the one-off lump sum and the new starter.  The situation is made worse by there often being no further income payments in the tax year which removes the possibility of automatic correction.

NOTE: It is often incorrectly stated that PAYE assumes that one-off payments will continue for the rest of the year and could make a different assumption.  PAYE makes no assumotions at all on what will happen in the future, it has no way of knowing.  What it does is to determine the tax due given the actual data up to the date of calculation.

 

molerat

PAYE simply gives you 1/12th of your annual allowance per month.  Take a large sum in April you will get 1/2th of the allowance and taxed on the rest using 1/12th of the relevant annual tax bands.  Take another in October you will be taxed on the whole April and October payments based on 7/12ths of the annual allowance and using 7/12ths of the annual rate bands less the tax you paid last time. The only way for PAYE to deduct the correct tax for the year is to take a payment in March which will set all of the payments against all of the annual allowance and all of the rate bands less the tax paid to date which may lead to a refund of tax being made in that payment. Anyone getting paid irregularly or large payments every few months will be treated the same. The system does know or assume anything.  Why do people suddenly want to take £15K in April and again in October when previously they were paid £2500 each month of the year and expect the system to treat them differently from someone earning £15K each month ?

This thread is probably prompted by the recent news about tax refunds for pensioners but I doubt that the measures being taken by HMRC are going to change the outcomes for the majority.  I suspect the problem has been that few have questioned likely an erroneous X code that has been allocated leading to too much tax being taken where a phone call would probably corrected it. Been there, done that, got it corrected !

swindiff

eastcorkram said:

MetaPhysical said:

Sanity check please on how this works?

So say I retire and I decide to take my first year's UFPLS payment early in the new tax year, with maybe another payment in October.  So something like this:

7th April £15k
7th October £15k

Ignoring TFC for this discussion.   Surely HMRC systems don't say to themselves "Ah, he took £15k on April 7th so his salary must be 12 x 15000 = 180k so we'll tax him 45% on that second payment" ???????  Surely in this AI era some common sense prevails and they'd know that I couldn't be on such a high salary having known my tax history for the last 42 years????

Can you not just divide what you want each year by 12, and draw it monthly?

Not always.  With my DC pension (USS), they do not offer drawdown and you can only take 4x UFPLS payments per year.

Qyburn

MetaPhysical said:

So say I retire and I decide to take my first year's UFPLS payment early in the new tax year, with maybe another payment in October.  So something like this:

7th April £15k
7th October £15k

Probably the first payment will be taxed exactly as you say, as if it was the first month of a year in which you're going to receive £180k.

If HMRC do their bit and issue a cumulative tax code then that should be used for the second payment which will then be taxed on the basis that you received £30k in the first 7 months, ie around £51k annual. You will pay too much tax as it will only use 7/12 of your tax free allowance. 

poseidon1

Caught this article below in my news feed today.

Whether HMRC' s undertaking from April 2025  to improve the tax treatment of sipp drawdowns, to reduce the occurrence of tax overpayments, would address the OP's conundrum remains to be seen.

https://moneyweek.com/personal-finance/pensions/pension-tax-hmrc-overtaxed?utm_term=88C8D3AB-801A-4BA2-9121-A59535747136&lrh=729ccc0544986d89d4ca75a2cc0e78738e9a6c52dec9dc1d0eab4f12ebe5bf8f&utm_campaign=595BDE43-CFD2-41D5-B4D0-B40A0A00BEBE&utm_medium=email&utm_content=9B56C99E-84F5-407D-A08B-4AB516C2E36F&utm_source=SmartBrief

Hoenir

MetaPhysical said:

 Surely HMRC systems don't say to themselves "Ah, he took £15k on April 7th so his salary must be 12 x 15000 = 180k so we'll tax him 45% on that second payment" ???????  Surely in this AI era some common sense prevails and they'd know that I couldn't be on such a high salary having known my tax history for the last 42 years????

Unless HMRC are clairvoyant. How do expect them to know what millions of individual tax payers are intending to do with their pension pots. Who is going to fund this extremely complex AI system. Common sense would suggest that taxpayers would consider it a waste of money. To handle the one off events that trigger what is little more than temporary inconvenience.