Taking tax-free cash from your pension at 55: It should be a last resort.
Covid has brought financial challenges for many people. Some have faced significant loses either with redundancy or damage to their business. Many people have been forced to make changes, to take jobs they may not have previously considered and to adjust to significant lifestyle changes.
When people are financially vulnerable, there comes an unstoppable flow of advertisements for quick fix solutions. Many people aged over 55 have been targeted with campaigns suggesting the easy solution to their financial problems is to release tax-free cash from their pension.
Few reputable independent financial advisers would encourage their clients to take the drastic step of solving a cashflow problem by dipping into their pension pot. It should be an absolute last resort, or part of a well managed retirement plan. Whilst many advisers take a cautious approach, there is growing concern that more people are susceptible to scammers who target them with fake investment schemes, using the hook of facilitating an easy pension withdrawal or pension loan.
The number of enquiries we have received from new clients asking about pension withdrawals has increased. We are very pleased to help people for whom the best decision is to access part or all of the pension savings, and put in place provision for their future pension income and a clear plan. At Furnley House we are not alone in receiving these enquiries. In fact figures of those accessing money held in their pension scheme are statistically rising. HM Revenue and Customs report that 360,000 people withdrew money during October, November and December 2020, a 10% rise compared to the same four months of the previous year. HMRC only receives information on taxable income, so this was people withdrawing money above their tax-free allowance*.
Whilst it may solve immediate financial problems, there are few benefits to withdrawing from your pension fund early. There are also a significant number of drawbacks. Generally it becomes harder to earn and save the older you become, so taking the option of a tempting quick fix can come at a high price later in retirement. Money you take because of financial pressures in your late 50s won’t be available to support you through a long retirement.
In this blog we explore some of things to consider if you are thinking about accessing money in your pension. We always advise you to have a conversation with an independent financial adviser before making any decision. You don’t have to be an existing client of Furnley House to receive advice on accessing your pension money and turning it into a retirement income.
Typically, the company you have saved your pension with over the years will only be able to provide you with limited advice choices and on the options it provides.
What are the rules about withdrawing money?
The rules surrounding defined contribution pensions were changed by the then chancellor George Osborne in his April 2015 Budget. He removed the requirement to convert a pension pot into an annuity, which provides a guaranteed income for life as was the traditional route people took when they wanted to transfer their savings into a pension income. This gave people more freedom to do what they wanted with their retirement money when they reached the age of 55. They could cash in some or all of their pension, or choose alternative ways to invest their money to produce income such as property or a portfolio of investments.
The Covid pandemic is the first time that the country has faced a serious financial crisis since the 2015 pension freedoms were introduced. It was never expected that retirement money would be used to solve large and immediate cash flow problems for everyday living. The pension rules do however provide the facility to access pension money and some people feel this is the right choice based on their current situation.
Once you reach the age of 55 you can take up to 25% of the money built up in your pension as a tax-free lump sum. You’ll then have 6 months to start taking the remaining 75%, which you’ll usually pay tax on, unless you’ve moved to a drawdown pension and selected nil income. The options you have for taking the rest of your pension pot include:
- taking all or some of it as cash
- buying a product that gives give you a guaranteed income (sometimes known as an annuity) for life
- investing it to get a regular, adjustable income (sometimes known as flexi-access drawdown)
The important point to consider is that if you access part of your pension savings as cash, you need to have a plan as to what you are going to do with the remaining money that is invested.
What are the tax implications?
Taking money out of a pension early has immediate tax implications. You can take 25% tax- free, but the rest will be added to any other earnings you have that year and could push you into a higher tax bracket. If you were to draw large sums and are still working, you may end up paying a higher rate of tax.
You should also be aware that your pension provider might charge you for withdrawing cash from your pension, so it is important to check this too.
Be careful if you plan to carry on saving into your pension.
Some people want to withdraw money from their pension for a specific purpose, such as paying oﬀ their mortgage, but they also intend to keep on saving for their retirement into their pension plan. However, taking out more than your 25% tax free allowance can aﬀect tax reliefs on future pension contributions.
At the moment you can pay up to £40,000, or all of your salary, into a pension and get tax relief on the contributions – this is known as your annual allowance. The tax relief is based on the rate of income rate you pay and is one of the significant benefits of pension saving. If you withdraw more than 25% the tax relief reduces, and your annual allowance is replaced by the “money purchase annual allowance” which is just £4,000 a year.
With a reduced allowance, rebuilding your pot will be more diﬃcult – and that problem will be made more challenging by the fact that you will not have as long for that money to grow before you retire. This is because compound growth works best when money is invested over a long time frame with regular contributions being made along the way. If you have taken a substantial portion of your fund in your 50s, you will most likely have to make significant contributions to get back to where you were.
Taking large sums of money out of your pension can also have knock-on eﬀects on other benefits you may be eligible to receive. For instance, if withdrawing a lump sum pushes your annual income to over £50,000 in a year, you may have to pay back child benefit through the high income child benefit charge. Universal credit, pension credit and council tax reductions might all also be aﬀected.
How can I consider these options sensibly?
This is where independent financial advice can really help. Making a cash withdrawal from a pension plan is only one part of a much bigger retirement picture. Getting advice can stop you making costly tax mistakes and will help you to have a clear plan with what to do with the remaining pension funds.
There are alternatives to making a cash withdrawal that you should consider. These include options such as investing your pension pot in a flexi-access drawdown fund. With this type of fund you can make withdrawals and buy a short-term annuity, which will give you regular fixed payments for up to 5 years, and you can still contribute to this investment plan.
Your financial adviser is there to help you and work with you. They won’t stop you making decisions about withdrawing money, but they will provide you with support and suggestions on how to best manage your retirement plans going forward.
To speak to an Independent Financial Adviser at Furnley House, call our oﬃce on 0116 269 6311 or email firstname.lastname@example.org. Our expert team will be able to provide you with all pension and retirement related questions.
Past performance is not a reliable indicator of future performance.
The value of an investment and the income from it could go down as well as up. The return at the end of the investment period is not guaranteed and you may get back less than you originally invested.
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