Next week is the sixth anniversary of 2015’s pensions reforms, which allow the over-55s to draw pension cash when they wish, while removing the obligation to buy an annuity at retirement. In the final quarter of last year, some 360,000 people withdrew a huge £2.4 billion, according to HM Revenue & Customs figures, up 10 percent on one year ago. However, pensions expert Stephen Lowe at advisor Just is warning that flexible withdrawals can backfire.
Pension withdrawals could hit your eligibility to claim means-tested State support such as housing benefit, council tax deductions, income support and income-based jobseeker’s allowance. “If you need to claim after losing income during the pandemic, taking too much cash could affect your entitlement.”
The Department for Work and Pensions does not take pension into account when assessing benefit claims, but that changes as soon as savers “crystallise” their pension by making withdrawals, Lowe said.
If you have children attending university, cashing in your pension could backfire. Lowe added: “Having sizeable non-pension savings may cut the amount of loan your children can receive.”
Money held in pensions has another advantage, in that it does not form part of your estate and become subject to inheritance tax (IHT) when you die.
This allows families to pass on their wealth tax-efficiently, and many advisers suggest retirees take funds from other sources such as Isas, as these may be liable for IHT when you die.
Most pensions are protected if you are made bankrupt, so those with businesses or financial problems might want to leave them untouched, Lowe added.
Pension withdrawals are added to your total annual earnings and subject to income tax he said.
“If you take out a large lump sum in any one year, this could push you into a higher rate tax bracket. Consider spreading withdrawals over several years to reduce the tax take.”
Lowe also warned that making pension withdrawals too early in life could hit the amount of income you have left to pay bills in old age. “Pensions are not like cash machines and withdrawals today can have long-term effects,” he said.
AJ Bell senior analyst Tom Selby said once you make a flexible withdrawal you trigger the money purchase annual allowance (MPAA), which permanently slashes the total you can invest in a pension in future from £40,000 to just £4,000.
The Government introduced this measure to stop people recycling large sums of money to claim tax relief but Selby warned: “If you trigger the MPAA, it could hit your ability to save in future.”
If unsure, seek independent financial advice or talk to free, independent Government-funded Pension Wise service.