Beware of hasty pension decisions

The current squeeze on people’s incomes might lead some people to consider drawing on savings. The Low Incomes Tax Reform Group (LITRG) is concerned that hasty decisions to take money out of pensions could lead to costly mistakes and is urging people to exercise caution and seek help.

LITRG’s warning comes after the recent launch of a Government call for evidence on ‘Helping savers understand their pension choices’.  

Pension flexibility means that many people with ‘money purchase’ or ‘defined contribution’ pension savings can do effectively what they wish with their accumulated pot of money, from age 55, increasing to 57 in April 2028.

While tax relief is usually given on money saved into pensions and investment growth is tax free, tax will likely have to be paid when money is taken out. Some of the knock-on effects can be unexpected and, without careful planning, can leave people with less money than anticipated.

An individual is allowed to take some money (usually 25%) out of their pension tax free, but the rest (usually 75%) is taxable as income. Taxable amounts will be added to other income, probably resulting in an extra tax bill.

The High Income Child Benefit Charge (HICBC) is a tax charge designed to claw back child benefit where either a taxpayer or their partner has adjusted net income in excess of £50,000. Child benefit is effectively withdrawn at a rate of 1% for each £100 earned by the higher-income partner over £50,000 a year. Therefore, the benefit is fully withdrawn where income of the higher-income partner reaches £60,000 a year. These figures apply for each tax year – so it’s necessary to look at income for the year starting in 6 April one year through to 5 April the next year. The taxable element of any pension withdrawals can therefore – perhaps unexpectedly – create or increase a HICBC. For more information about the HICBC, click here to read our recent article Understanding the High Income Child Benefit Charge.

Kelly Sizer, Senior Technical Manager for the LITRG, said:

“We urge people not to rush into making decisions about pension withdrawals without fully exploring the tax and other consequences of their actions, including impacts on welfare benefits.”

“We know of people who have received very large tax bills, often unexpectedly, since pension flexibility began. For example, in households where there is a child benefit claim in place, tax charges can include a high income child benefit charge when a pension withdrawal pushes the person’s adjusted net income over £50,000. This also means the taxpayer must notify HMRC they are liable for the tax and fill in a Self-Assessment tax return.”

“People should plan ahead where possible. They might pay less tax on money from pensions if it is taken in stages, spread out over a number of tax years, or withdrawn after they have stopped work. For those on lower incomes, tax credits and benefits impacts also need consideration – for example, the taxable element of pensions is also taken into account as income for tax credits.”

“Think about the future. If you are looking to take money out of a pension to get you through a spell of financial difficulty, you might wish to pay into a pension again in future if the squeeze on your income eases. However, once you have taken pension benefits under the pension flexibility rules, future tax relief is restricted such that you are limited to paying in £4,000 gross a year, the ‘money purchase annual allowance, which is a possible tax trap to beware of.”

Our advisers use cashflow planning to assess retirement plans; Click here to get in touch with a TPO adviser.

The information in this article is correct as of 26/07/2022. 
The Financial Conduct Authority (FCA) does not regulate cash flow planning. The value of your investment can fall as well as rise and is not guaranteed.