Short-term tax savings could be prompting pre-retirees to make a major pension mistake. Defined contribution pensions can result in a tax charge depending on how its used, leading many to seek potential loopholes.
The 25% tax-free lump sum option is a popular choice, but one expert is raising their concerns. Rowan Harding, from Path Financial, warned: “When you’re approaching retirement, you will have to decide when and how much of your pot you should take.
“This will have big ramifications in terms of what you’ll get and how long that cash will last.”
Typically, people are permitted to draw 25% of their defined contribution pensions without tax or affecting their personal allowance. Following this, pension providers deduct any due taxes from the remainder of the fund.
However, Rowan cautioned against hastily making the most of this tax-exempt path. They said: “There is a minimum age, currently 55, when you’ll be able to take some or all of your pension money. But accessing your pension too early may not be sustainable in the long term. It takes careful planning to understand ‘when, how and what’ when it comes to taking your pension.”
While the expert acknowledged that there could be circumstances where taking the 25% early is beneficial, such as being seriously ill and needing the money for treatment, Rowan still urged people to be cautious and put the sustainability of their pension fund first, warning: “Your pension is meant to last.”
Dipping into your pension beyond the tax-free 25% limit triggers income tax on any earnings above the personal allowance. Pensions, including state benefits, are considered income for these tax purposes, but the exact amount you will be liable for depends how much total income you have – more information can be found on Gov.uk.
With the personal allowance currently frozen at £12,570, and the full new state pension approximately £11,500 yearly, people can only withdraw roughly £1,060 from their private pension or other incomes each tax year without tipping over the threshold.
But the spotlight should not just be on tax savings. It’s crucial to consider future financial requirements too, Rowan advised: “Remember, planning now to make sure you are saving enough for your future, knowing when and how to take your pension or if leaving the pension pot to continue growing is best for you, is always worth checking with an expert Financial Planner”.
