Whilst many people will undoubtedly benefit from Pensions Freedom, which started in April, new research has shown thousands of people are potentially making a very costly mistake.
Under the new rules anyone over the age of 55 can make unlimited withdrawals from their pension pot. The first 25% you withdraw is tax-free, with the balanced added to your income in the tax-year they money is taken out and then taxed.
Why are people taking money from their pension?
Many people, who have saved hard for retirement, are not taking large lump sums, preferring to use their pension pot for its original purpose; to provide an income in retirement.
However, research by Royal London who surveyed 800 customers revealed that many people are taking large lump sums under the new rules:
- 70% of those people surveyed wanted to withdraw all of the money in their pension pot in one go
- The average size of pensions being fully cashed in was £14,100; according to Royal London this would lead to an average tax bill of over £3,000
- 16% of people using Pension Freedom wanted money to repay their mortgage or other debt
So what’s the mistake thousands of people are making?
A third of people withdrawing all the money from their pension pot, were doing so just to put it into a bank account or other investment.
Indeed 23% of people planned to leave the money they have taken from their pension in a bank account or Cash ISA (Individual Savings Account).
6 reasons why is taking money from your pension, to put into a bank account (or other investment) is a mistake
- Although there are a few exceptions, most people who withdraw more than 25% from their pension will be hit with an income tax bill. There is no logic in paying tax, just for the money withdrawn from the pension to sit in a bank account
- Under the new rules money purchase pensions e.g. Personal Pensions, Stakeholder Pensions and SIPPs (Self-Invested Personal Pensions) can be accessed at any time after the age of 55. There is again no logic in taking money out of a pension, paying tax unnecessarily, when it can still be accessed in the future as and when needed
- Interest rates on deposit accounts are currently poor and may provide a lower return than your pension would have done if it had been left untouched
- Furthermore, certain types of pension, SIPPs, can open deposit accounts. So, if you want to hold your pension pot entirely in Cash this is perfectly achievable without withdrawing money and triggering a tax charge
- If it is the tax-free status of a Cash ISA which appeals to you, it is worth remembering that no tax is paid on interest received by deposit accounts held within a SIPP
- Some people may have taken money out of their pension to reinvestment in Stocks & Shares ISAs. Again it’s worth remembering that generally speaking a pension can invest in exactly the same funds as an ISA. Furthermore, a pension is a tax-efficient way of investing, as is an ISA. Again, it makes no logical sense to pay income tax to move from one tax-efficient product, a pension, into another, an ISA
It’s clear from the research that many people will be paying income tax unnecessarily. Indeed when the plans were unveiled the Government predicted that Pension Freedom would raise billions in extra tax.
In short, don’t take money from your pension unless you really have to.
Of course review the way it is invested, the performance and what you are being charged. But unless you need the money, don’t take it out, all you will be doing is triggering an unnecessary, and potentially large, tax bill.
Are you thinking of taking money from your pension? We’re here to help
If you are thinking of taking money from your pension, and would like our advice to confirm whether or not you are doing the right thing, we are here to help.
Call Sarah or Bev on 0115 933 8433 or email email@example.com