People approaching retirement are being warned that taking all their pension savings at once could leave them facing a much bigger tax bill than expected. New analysis from financial advice firm NFU Mutual found hundreds of thousands of people aged between 55 and 64 completely emptied pension pots when accessing them for the first time.
Thousands Cash Out Pension Pots
Financial Conduct Authority figures show 319,265 people in this age group fully cashed in pension pots when first accessing them in the year to March. Across all age groups, almost half of the 1.047 million pension pots accessed for the first time during the year were completely withdrawn.
The tax consequences can be substantial because only 25% of a pension pot can usually be taken tax-free. If the whole pot is withdrawn, the remaining 75% is normally treated as taxable income for that year. That means someone who is still earning a salary could find themselves pushed into the 40% or 45% income tax bands.
Tax Bill Example
Those whose total income exceeds £100,000 can also begin losing their personal allowance. NFU Mutual gave the example of someone earning £50,000 who decides to cash in a £100,000 pension. After taking £25,000 tax-free, the remaining £75,000 would take their taxable income to £125,000. According to the firm's example, their income tax bill would jump from £7,486 to £42,432.
Sean McCann, chartered financial planner at NFU Mutual, said: "Many people do not realise that emptying pension pots in one go can trigger a significant tax bill."
Further Restrictions
Tapping into a pension after you reach 55 can be enticing but taking a taxable payment limits how much you and your employer can subsequently pay into your pension. Considering many workers over 55 will be at the peak of their earnings they risk missing out on contributions from their employer as well as valuable tax relief.
Taking taxable income from a pension can also trigger the Money Purchase Annual Allowance, restricting how much can subsequently be paid into defined contribution pensions with tax relief to £10,000 a year. NFU Mutual said 337,823 of the 479,485 pots completely cashed in were withdrawn without the owner receiving regulated advice or guidance from Pension Wise - around 70%.
Mr McCann also warned people to consider what happens to money after it leaves their pension. He added: "Many people cashing in their pensions do so without a clear idea of what they plan to do with the money, often putting it into a bank account. Whilst money is in a pension any growth is free from UK income tax, capital gains tax and until April 2027 free of inheritance tax. Money taken out of a pension is often exposed to some or all of these taxes."
