‘Vital that savers know’ Britons warned of tax bill up to 45% on early pension withdrawals

Rishi Sunak 'taking money out of our pensions' says economist

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As the cost of living crisis continues and energy bills rise, many people may be considering taking out money from their pensions to fund their lives now. However with inflation sitting at nine percent, and income tax rates applied, Britons are urged to be careful as their money will decrease but also lose value early on in their retirement.

Express.co.uk spoke exclusively with Liam Chapman-Lyes, chartered paraplanner at Succession Wealth, on the pitfalls that savers should know before accessing their defined contribution pensions.

He said: “Accessing defined contribution pensions could lead to income tax rates of up to 45 percent, so it is therefore vital that savers know the pitfalls or seek professional advice from a qualified Financial Planner.

 “Accessing defined contribution pensions from age 55 when done correctly can allow many savers to retire early or enter phased retirement while still working or reducing their hours. 

“This can be life changing, but it is important savers are fully aware of the pitfalls.”

Defined contribution pensions are usually the most common and people can take 25 percent of their pension free of income tax. 

Usually this is done by taking a quarter of the pot in a single lump sum, but it is also possible to take a series of smaller lump sums with 25 percent of each one being tax-free.

The income people might get from a defined contribution scheme depends on factors including the amount they pay in, the fund’s investment performance and the choices they make at retirement.

Currently it can be accessed by age 55, however this may rise.

Mr Chapman-Lyes continued: “Pensions are a great way to pass on wealth to beneficiaries without being included in your estate which could incur the much debated 40 percent inheritance tax. 

“Savers should think twice before accessing their pensions if they have other savings and investments. If savers are fortunate to have other sources of wealth or income it would be prudent to access these first.

 “Savers can access up to 25 percent of their pension pots tax free without triggering the Money Purchase Annual Allowance (MPAA).  

“Many decide to, but is important savers have a well thought out retirement plan and budget to avoid running out of money in retirement.”

The MPAA is a special restriction on the amount someone can pay in to their pension and still receive tax relief. 

It kicks in when they start to access their pension pot for the first time.

The main situations when someone wll trigger the MPAA are: 

  • If they take their entire pension pot as a lump sum or start to take lump sums from their pension pot 
  • If they move their pension pot money into flexi-access drawdown and start to take an income
  • If they buy an investment-linked or flexible annuity where their income could go down
  • If they have a pre-April 2015 capped drawdown plan and start to take payments that exceed the cap.

The MPAA won’t normally be triggered if:  

  • They take a tax-free cash lump sum and buy a lifetime annuity that provides a guaranteed income for life that either stays level or increases 
  • They take a tax-free cash lump sum and put their pension pot into flexi-access drawdown but don’t take any income from it 
  • They  cash in a number of small pension pots valued at less than £10,000. 

Mr Chapman-Lyes explained that if savers continue to work, they should be in workplace schemes that contribute into their pension.

If savers have accessed any income from their defined contribution pension – that is after they have taken their tax-free cash – then they would have a reduced MPAA from £40,000 to £4,000 per annum. 

He added: “This could lead to disappointment as savers could lose out on free cash from their employer towards their retirement.

“Since the pensions freedom legislation came into force in April 2015, savers have been able to flexibly access their defined contribution pensions from age 55, increasing to 57 from April 2028.

“Many savers should be aware of this change and if appropriate to do so, plan to access their pensions accordingly to avoid waiting an extra two years.”

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