Retirees risk pension tax shock

Published by Rachel Lacey on 20 July 2018.
Last updated on 20 July 2018

Tax

As many as one in 10 (10%) of people retiring this year plans to take their entire pension as a cash lump sum, according to research from Prudential, while one in five (20%) plans to cash in more than their tax-free allowance.

The findings are part of Prudential’s Class of 18 report, a series of annual studies that track the plans and aspirations of people as they retire.

Under current rules, only 25% of your pension savings can be withdrawn tax free. Withdrawals in excess of this are added to your income for the year and taxed at your marginal rate.

This means any savers cashing in more than 25% of a pension risk a substantial tax bill and risk jeopardising their retirement income.

According to government figures, more than 1.1 million over-55s have withdrawn £15.744 billion in flexible payments since the introduction of the pension freedoms in April 2015. In the following two tax years this has netted the government £2.6 billion, with a further £1.1 billion in 2017/18.

Although cash withdrawals make sense for retirees with small pots or significant at-retirement expenses such as debts to clear, wealthier retirees can end up paying a fortune in tax.

However, the Prudential research found that this is not usually the priority of savers making cash withdrawals.

The main reason, for 71% of those polled, was to move the money elsewhere – buying a property, putting it into a savings account or investing in a stock-market-linked investment. This is despite pension savers being able to invest in cash or the stock market more tax efficiently within a pension.

Of those who spent the money the most popular reason at 34% is to pay for holidays, followed by home improvements at 25%. One in five (20%) gave money to children or grandchildren, another one in five used it to buy a car, while only 18% used it to pay off the mortgage.

Commenting on the results, Stan Russell, a retirement income expert at Prudential, says: “Pensions freedoms allows savers to have the flexibility on how and when to spend their money without being penalised by the tax system, but it is worrying that so many will withdraw more than the tax-free lump sum limit.

“The risk is even greater for those who are taking all their pension fund in cash. They not only face paying more in tax than they have to, but also put their long-term retirement income security at risk.

“Consulting a professional financial adviser in the run-up to retirement or seeking guidance from the free resources available including The Pensions Advisory Service can help to plan ahead. This would ensure people access their pension in a way that benefits their long- and short-term aims without giving too much to the taxman.”

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