A real pension pot palaver
The pension major pension reforms introduced four years ago aimed to give people more control over their retirement income, allowing pension savers over the age of 55 to withdraw money from their pension pots whenever they like. Since 2015, more than one million people have withdrawn around £23.6bn from their pension pots. In the final six months of 2018 alone, 448,000 savers withdrew £6.13bn of retirement income.
However, there has been a sting in the tail. Retirees have been overtaxed by a staggering £400m since the
pension rules were changed.
There are two ways to withdraw pension money: an ‘uncrystallised fund pension lump sum’, where 25 per cent is tax free and the rest is taxed, or to take a lump sum from a pension drawdown plan, with the first 25 per cent being tax free and any subsequent withdrawals subject to income tax.
All the tax is handled by the pension company, so people get the net sum. But it turns out that when making the first withdrawal people have been charged on an emergency tax rate. Which means a £10,000 withdrawal could see you end up being taxed as though your annual income is £120,000. This is because your pension company doesn’t know what your tax code is, or details of your other income, if you have any.
Unsurprisingly, this emergency tax rate can go unnoticed, but it leads to significant sums of cash being lost. As a result HMRC has had to refund £402,743,108 in the last four years when the problem has been flagged - the average claim coming to £2,161.
But this money has only been repaid because people have reclaimed it - what about the rest who have yet to realise they’re paying too much in tax? Make it a priority to check just how much tax you are paying, and have paid since 2015.
And if you’re planning to make your first pension withdrawal, make sure you check the tax liabilities very carefully.
The new pension freedoms offer more flexibility and control but before you start dipping into your pot remember your retirement savings need to last you the rest of your life – so before you make a decision, ensure you fully understand the consequences and seek financial advice.
Harry Rose is editor of Which? magazine. Send your consumer queries to askharry@which.co.uk