Cash cut dilemma
Financial worries or just looking for better value for money? Consumer champion Fergus Muirhead answers your questions Releasing your pension funds early is not always the best way to get hold of finance
QRECENTLY I applied for a 25 per cent early pension release – about £10,000, which I was told was tax-free. When I got my cheque, it was for £8000.
Iain Wallace
AI’D LIKE to begin by addressing the issues in your email and then make some general points about the way people with personal pensions seem to be accessing the cash in these funds. First of all, let’s deal with your question. You don’t say how old you are but I am working on the basis that you are over 55 since you are looking to release money from your pension now. I’m also assuming it is a personal pension that you are taking the money out of. If both of these assumptions are correct, you should be able to take up to 25 per cent of the value of your pension fund as a tax-free lump sum. From your figures, it looks as though your pension company have taxed you at 20 per cent on all of the money you received. It may be they have simply made a mistake, or it could be they thought you were taking cash from the taxed part of your pension rather than the tax-free portion. If you have previously taken cash from your pension fund, for example, you may well have already used up your tax-free element. If that is the case, the rest of the money you take out will be taxed at your marginal rate, in other words the rate you currently pay income tax.
You need to contact your pension provider straight away and tell them that as far as you were concerned the money you received should not have been taxed.
Ask them why they taxed it and then feel free to come back to me with their response if it doesn’t make sense.
For other readers thinking about taking money out of a pension, it is really important to understand the tax implications of doing so.
When the Chancellor introduced pension freedoms a few years ago, he was very keen to let people know that they
should have the right to take as much money as they wanted out of their pensions as soon as they reached the age of 55.
He was less clear about the implications of doing so, and the fact it could lead to a substantial tax bill, as well as a much-reduced pension in later life.
This means that we need to be really careful when deciding when, and how, to access money that is in our pensions.
It’s all well and good to know that it’s your money and you can have it whenever you like.
But if the decision to take it too early – when you perhaps don’t really need it – costs you money in extra tax payments then perhaps you need to think about how else you could access that cash.
The starting point is to ask why you are withdrawing the money from your pension in the first place.
It’s not enough to say, “Because I can.” The fact that you can do something doesn’t always mean that you should do something.
There is clear evidence now that more people are accessing cash from pensions early and, in some cases, moving money from guaranteed final salary schemes to more flexible but riskier personal pensions so they can do so.
In many of these cases, there could have been other ways to get hold of money and it may well have made more sense to do that and leave the money in pensions intact until later.
If you have money in an ISA, or a savings account in the bank, or if you have shares or even a second property that you rent out, it might be better to use that money before you take money out of your pension.
It might even be better to borrow money that is lying around in your house by using some sort of equity release mortgage.
What is really important is that you understand the tax implications of all of the decisions you make regarding the way you access money when you stop work, or get close to stopping work, and how these decisions impact the money that you will eventually pass on to your children or other dependents.
It makes sense to sit down and talk to a properly qualified financial planner who can help you make the best decisions.