Some people planning to take money from their pension have been warned that their plans are “bonkers”.
Most people started a pension to provide an income when they finished work. However, figures from Retirement Advantage, have revealed that 24% of pre-retirees, who are still working, plan to take even more money from their pension, despite having already used their tax-free lump sum.
The main reasons for taking extra money are:
- Using it to pay an income (28%)
- Home improvements (17%)
- Repaying debt (17%)
- Boosting savings (28%)
It is this final group which is causing concern.
Pension Freedoms allow more flexible withdrawals
The new Pension Freedom rules, allow anyone over the age of 55 more flexibility in the way they withdraw money from their pension:
- You can take up to 25% of your pension pot as a lump sum, with no tax deducted
- Any further withdrawals are added to your other income and taxed accordingly, at a rate of 20%, 40% or even 45%.
Experts are concerned about people taking money from their pension to simply boost their savings.
Andrew Tully, Pensions Technical Director at Retirement Advantage explains the problem: “While paying off debt can be a good use of the money, stripping out cash from a pension to save it for a rainy day is frankly bonkers. You might be surprised at just how much tax you will pay on any withdrawal, before you consider how little interest you will earn on savings at the moment.”
“We need to start a conversation around pensions which gets back to basics. People need to remember why they initially saved for the longer term, to pay them a salary in retirement. The pension changes have given people the opportunity to take control, but, left to their own devices, many are at risk of making poor decisions. Pension Wise and financial advice should be promoted at every opportunity if people are to avoid costly and irreversible mistakes.”
Low interest rates and inflation
Andrew Tully’s comments are re-enforced when we look at the interest rates savers can expect to get.
The highest paying account currently gives an interest rate of 2%; if you are prepared to tie up your capital for a full five years.
At that rate, it would take a basic rate taxpayer (20%) 12-years to ‘breakeven’ and see their capital return to the same level that was withdrawn. In other words, it would take 12-years for the interest received to equal the tax paid.
That’s bad enough, but the situation is even worse when we remember that if the money hadn’t been withdrawn, and was retained in the pension, it would have continued to grow.
Finally, factor inflation in, which will reduce the effective rate of return on the money withdrawn, pushing the breakeven point even further away.
If you are thinking about taking money from your pension to boost your savings, we would suggest you think again:
- Before you make any decisions, make sure you know exactly how much tax you will pay on the withdrawal
- Calculate too whether you can afford to withdraw capital. How much will it reduce your future income? Will it leave you unable to pay your bills in years to come?
- If you prefer the idea of holding your capital in Cash, you could consider using a SIPP and a series of deposit accounts. Rather than withdrawing money, paying tax, only to hold the capital in a savings account
- Finally, remember that if you decide not to withdraw money and it turns out that you do need the capital in months and years to come, the Pension Freedom rules are unlikely to change. You could come back to take money from your pension in years to come
As we said at the start of this article, most people put money into their pension for retirement. This goal probably shouldn’t change just because the rules have done.
If you are thinking of taking money from your pension, we are here to help you make the right decision and ensure you don’t make a costly mistake.
Call Sarah or Bev on 0115 933 8433 or email info@investmentsense.co.uk
