Albert Einstein once said that "the hardest thing to understand in the world is income tax".
Now from the man who gave us the Theory of Relativity that is quite a statement. I would like to say that I had an interest in theoretical physics but being honest only to the extent of the next episode of the US sitcom The Big Bang Theory.

On the other hand I do consider I have a good grasp of income tax. That said the theory of how the income tax system works is reasonably logical and straight forward, however when it come to putting it into practice the outcomes can be nonsensical, even perverse.

Media reports suggested that 1 million people attempted to contact HMRC in one day at the start of the new tax year hoping to clarify their income tax bill on flexible pension withdrawals now available to them under the pension freedoms legislation. At James Hay we have also been inundated with members wanting to know if they take ad hoc payments what net income would they actually receive. To work out the actual overall tax liability is not complex.

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There are many tools available online to assist. The problem lies in the fact that the PAYE system was designed as a means of ensuring that the correct amount of tax was deducted from regular income withdrawals. In these stable circumstances the process works well but as soon as you introduce ad hoc withdrawals into the mix the system stalls and there are a number of different options a member can take to rectify the position.
The main point is members may not initially get as much income as they were expecting due to an overpayment of income tax and how quickly they will get a refund of the overpaid tax could vary anything from weeks to over a year.

This may cause unexpected cash flow problems so it is important for the member to have realistic expectation of what income they will receive up front and what they need to do to get a prompt refund of any overpaid tax.

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If we take a simple example, Leonard is semi retired and has income of £10,600 from lecturing part time. He takes a one-off payment of £20,000 to pay for his daughter's wedding from his crystallised pension fund. As this will keep him well within the basic rate band he expects to receive a net income of £16,000 however as the pension provider had to apply an emergency tax code he only gets £12,551.

The overpayment of income tax of £3,449 may be refunded later by the pension provider if they are able to process PAYE refunds, if not Leonard could make a claim in the tax year or wait till the end of the tax year to make the claim through his tax return or just wait HMRC to make the calculation and pay the refund.

The PAYE system has stood the test of time but pension flexibility does bring its weaknesses to light. Advisers will have to understand how their pension providers operate their PAYE system and what steps can be taken to try and ensure their clients are not too inconvenienced and that they have an understanding how the PAYE process works before making large withdrawals.
In the words of Dr Sheldon Cooper "Bazinga".