Pension freedoms have provided more choice, but is cashing in right for you?
By Paul Bullivant, Financial Adviser NFU Mutual
CHANGES to pension rules in 2015 were designed to provide more freedom to retirees. Since then, the Financial Conduct Authority (FCA) says that dipping into pension pots early has become ‘the new norm’.
Almost three quarters (72%) of pots that have been accessed are by people under age 65, with most choosing to take cash lump sums rather than a regular income. Meanwhile, 53% of retirement pots accessed had been fully withdrawn.
Michelle Cracknell, chief executive of The Pension Advisory Service, says: “Taking money from your pension pot is a big decision. You may have old pensions with special rules, you may have to pay tax and you may make some decisions that cannot be changed. It’s very important to take your time, and consider all the available options.”
Here, we consider seven of the traps that might exist when drawing money from your pension.
If you cash in the whole of your pension, the first 25% will normally be tax-free, with the remaining 75% added to your other income and taxed. This makes it vital to consider the tax impact of withdrawing lump sums from your pension. You could find doing so pushes you into a higher income tax bracket, or that you face an unexpected tax demand.
For example, let’s say you have earnings of £30,000 and you decide to cash in 100% of your pension pot, which is worth £100,000. You will be treated in that financial year as if you have an income of £105,000 (£30,000, plus 75% of £100,000), which could result in you paying more than £27,000 extra tax to the tax man.
However, by spreading withdrawals from your pension over a number of financial years, this could reduce the impact of any tax liabilities.
Withdrawing if you are still working
Taking a taxable payment from your pension while you are still working will reduce the sum you can pay into your retirement pot.
Since April 2015, there has been a limit on the amount of pension contributions you and your employer can make if you have already taken a taxable withdrawal from your pension. This is known as the Money Purchase Annual Allowance, and currently stands at £4,000.
This cap was introduced to prevent income drawn from a pension being paid back in for additional tax relief, following the introduction of pension freedoms. This cap could mean you miss out on valuable employer pension contributions in addition to your own.
Maximising tax benefits
In a pension any growth is free from UK Income Tax and Capital Gains Tax. If you take the money out you could be exposing your investments to tax. For example, if you withdraw money from your pension and put it into a bank account or invest in shares, any interest or dividends could be liable to UK Income Tax.
Inheritance Tax protection
Since the removal of the 55% pensions ‘death tax’ in 2015, the tax treatment of pensions on death has dramatically improved.
Pensions are normally considered to be outside your estate and in most circumstances are therefore free of IHT. If you cash in your pension and invest the money elsewhere, you could be exposing it to IHT. Don’t give up this valuable protection without taking advice.
Losing valuable guarantees
Many pensions set up in the 1980s contain guaranteed annuity rates, meaning the pension provider guaranteed the rate they would use to convert the fund into income.
These can be many times higher than the rates available on the market today. Get the policy checked so you can make an informed decision. Even on small pots that you might be tempted to cash in, guaranteed annuity rates can make a huge difference.
Exposure to pension scams
Since April 2014, £43 million has been lost to pension scammers. They may cold call you to tell you that they have an unbeatable investment opportunity, which should ring alarm bells. Bear in mind that fraudsters can be particularly convincing and clever to persuade you to part with personal information.
If you are unsure about a particular company or opportunity, contact The Pension Advisory Service (TPAS) for help on 0300 123 1047, or visit their website at www.pensionsadvisoryservice.org.uk
Understanding life expectancy
Latest ONS statistics state that the UK life expectancy for 65 year olds is now 83 for men and 86 for women, meaning we are likely to spend longer in retirement than previous generations. It has therefore become even more important that you do not run out of money and have an effective financial plan in place.
YOU NEED TO KNOW
- The value of pensions can fall and you may get back less than you invested.
- The tax treatment of pensions depends on your circumstances and may change in the future.
GET IN TOUCH
If you would like more information speak to your local NFU Mutual Agent at:
NFU Mutual, 144 High Street, Sevenoaks, Kent, TN13 1XE.
Branch opening times: Monday- Friday: 9am Until 5 pm.
Or phone 01732 496050 and we will put you in touch with your personal Financial Adviser.
Phone lines are open: Monday- Friday 9 am Until 8 pm + Saturday: 9 am Until 12:30 pm.
NFU Mutual Financial Advisers advise on NFU Mutual products and selected products from specialist providers. We’ll explain the services and charges. Financial advice is provided by NFU Mutual Select Investments Ltd.