Risks of pension freedom
A RECORD one million Britons are turning 55 this year and can dip into their pensions for the first time, but experts warn many could ruin their retirement by making simple errors.
The pension freedoms that came into force in 2015 put people in charge of their retirement savings, but they need to be handled with care.
Savers who rush to withdraw money from their pension funds could end up locking in the losses they made during the stock market crash, while incurring a major tax bill. This is a concern as half of those turning 55 this year say they know little about pension freedoms, while one in 10 have never heard of them.
Despite that, more than half plan to draw some money from their pension before they reach State pension age.
The research comes from pensions provider Standard Life, which warned that many risk depleting retirement savings too quickly and running short of money in later life.
Under pension freedoms, savers are free to dip into personal and company pensions from age 55, although the process is more complicated for “defined benefit” final salary schemes.
More than a third have already withdrawn savings before the State pension age, but Standard Life head of customer communications Laura Laidlaw warned: “Five years on there is still a lack of awareness and people risk making decisions that are not best for them.”
While 25 per cent of withdrawals are free of tax, the remaining 75 per cent are added to your earnings for that year, and subject to income tax.
If you withdraw too much in one year, you could get a bill pushing you into the 40 or 45 per cent tax bracket.
Making withdrawals amid current stock market volatility is particularly dangerous. “You risk locking in the losses you made during the stock market crash,” Laidlaw said.
History shows that stock markets recover over time, so the less you draw now, the better: “Rely on ‘rainy day’ cash savings and other reserves of income where possible.”
Remember that your pension pot must last throughout retirement. Laidlaw added: “Taking too much too soon could put you at risk of running out of money when you need it most.”
If you withdraw more than the 25 per cent tax-free cash limit, this will restrict the pension contributions you or an employer can make into your pension in the future. “Under the Money Purchase Annual Allowance, they would be restricted to a maximum £4,000 a year,” she said.
You could get round this by only taking your tax-free cash: “You could then contribute up to £40,000 a year, if you have the earnings to do so.”
If confused, you can get free, impartial guidance from the Pensions Advisory Service and PensionWise.
When drawing money from your pension, beware scammers. City of London police reported a 400 per cent rise in Covid-19 related fraud.
Only deal with any advisory or investment firm that is registered with the Financial Conduct Authority. Check its lists at Register.fca.org.uk or visit the FCA’s ScamSmart website at FCA.org.uk/scamsmart.