Since the Pension Freedom rules were introduced in April 2015, the majority of pension providers have offered the option of withdrawing your full personal pension fund as a lump sum, once you reach the age of 55 – but there are a number of drawbacks to be aware of.
Is your pension better left invested?
The main purpose of any pension is to provide money to live on once you stop work. Obviously withdrawing money from your pot before you retire will reduce what you have left to live on in your later years. So ask yourself if you really need the money now, or are there any alternative ways you could raise funds?
The other factor to consider is that personal pensions are invested on your behalf, with the aim of growing in value over the years. 25% of the pot is normally available as a tax-free lump sum, so as the pot grows so does the value of the tax-free money. Withdrawing the pot well before retirement means you could miss out on many years of growth.
You also may be withdrawing because you think your money will be safer in the bank and not invested – but the reality is that no-one can predict the markets. If you are really concerned, it may be possible to speak to your pension provider about switching into more cautious funds or even a deposit fund for a short time, without cashing in the whole pension.
The fact that you can withdraw your pension pot as a lump sum can be a bit misleading, as the majority (normally 75%) is actually treated as income and taxed accordingly. This means that you could end up paying a lot more tax than you need to, particularly if you push your overall income for the year into higher rate tax, or the level at which your personal allowance would be affected.
To make matters worse, pension providers have to tax you on an emergency tax code, meaning you are likely to pay more tax upfront and then get a rebate at some point down the line.
State benefit implications
The other area that can be impacted is state benefits, many of which are means-tested. Even if you are only accessing a relatively small pension fund, the additional money treated as income could affect your benefits.
Child benefit can also be impacted if you push your income over £50,000 for the year.
Further pension contributions
Taking your pension as a lump sum can trigger the Money Purchase Annual Allowance (MPAA), which restricts the amount you can then contribute to a personal pension. The MPAA limit is currently £4,000, but this could reduce in future. This £4,000 limit includes employer contributions, so if your employer has a workplace pension scheme with generous contributions you may no longer be able to take full advantage of this.
The MPAA is not triggered if the “small pot” rules apply, for example if the individual pension fund value is less than £10,000 (and you haven’t already accessed more than 2 pensions this way).
We are always available to discuss any queries or concerns, so just call or drop us an e-mail.
The value of your pension or investment can go down as well as up and you may not get back as much as you originally invested.
The area of taxation is not regulated by the Financial Conduct Authority (FCA).