Planning to take money from your pension? Beware of the tax!


Tax problem conceptNew research shows that some people are being hit with surprise tax bills, when they use new rules to take money from their pensions.

The report, from Citizens Advice, considered 500 people who had taken money from their pension; 9% had a surprise tax bill, whilst 6% had their benefits affected.

Pension Freedom was announced in 2014 and started in April 2015. One of the new rules allows anyone over the age of 55 to take an unlimited amount of money from their pension. People taking advantage of the new rules can take up to 25% of their pot tax-free with any further withdrawals added subject to tax.

How is the tax bill calculated?

The tax is calculated by adding the amount withdrawn to your other income in the same tax-year and then applying the appropriate rate. For example, if when added to your other income, the withdrawal stays below the higher rate tax threshold, tax will only be payable at a rate of 20%. However, if it takes your total income over the higher rate threshold some tax will be payable at 20% and some at 40%.

So far, nearly a quarter of a million people have taken money from their pension under the new rules and given the research from Citizens Advice there has to be concern that many thousands are being left with unexpected tax bills as a result.

And it’s not just about tax, pensioners could unwittingly be reducing their entitlement to state benefits by taking money from their pension and holding it in a bank or savings account.

How can you minimise your tax bill?

No one wants to pay more tax than they have to, here are a number of options for reducing the tax you pay in relation to your pension and potential withdrawals:

#1: Don’t take the money out: This might sound obvious, but 29% of people took money from their pension fund only to put it into a bank account. Now, some of this money may have only been held in the bank temporarily, before it was used for another purpose. But, if you are simply taking money from your pension, to boost your savings, it’s probably worth thinking again. Is it worth paying tax just to do this, when the money is still accessible from the pension, if you need it at some future date?

#2: Take only what you need: Following on from #1, it’s usually wise to only take from your pension exactly the amount of money you need, not a penny more. Capping your withdrawals will limit your tax bill

#3: Use the tax-free lump sum: If you do need money use the tax-free lump sum first, saving the remaining 75% until the future when your other earnings, or other income, may be lower and you will consequently pay less tax

#4: Consider other options: You may have other savings and investments, such as ISAs (Individual Savings Accounts) which won’t trigger a tax charge when you withdraw money. It’s worth spending time carefully thinking about the most tax-efficient place to take money from

#5: Wait: In all likelihood your pension will need to pay you an income for the rest of your life, therefore, taking too much money from it, too soon, is dangerous. This is the fundamental reason for waiting before you withdraw money, however, there is another. If you take money out whilst you are still working, you are likely to maximise your tax bill, simply due to the fact you will probably be earning more in work than retirement

#6: Put the dogma to one side: Some people have always held a rather negative view of pensions. The new rules gave these people the opportunity to withdraw all their capital simply because they didn’t like or trust pensions. This really is a very poor reason to trigger a potentially large tax bill. Much better to think carefully, take some sound advice and a more sensible approach which will probably leave you better off

We are here to help

With potentially thousands of people taking money from their pension, only to trigger a surprise tax bill or drop in state benefits and perhaps many more taking too much money, too soon, leaving themselves destitute in old age, caution and careful planning is important.

If you would like to consider how the new rules can help you provide the retirement you had always hoped for, we are here to help.

Call Sarah or Bev on 0115 933 8433 or emai