Cost of living crisis: beware of hasty pensions decisions, warn tax experts

The current squeeze on people’s incomes might lead some people to consider drawing on savings. The Low Incomes Tax Reform Group (LITRG) is concerned that hasty decisions to take money out of pensions could lead to costly mistakes. The group urges people to exercise caution and seek help.
LITRG’s warning comes after last week’s launch of a government call for evidence on ‘Helping savers understand their pension choices’. 1 In LITRG’s experience, people often do not understand enough about the tax consequences of their decisions.

 

Pension flexibility2 means that many people with ‘money purchase’ or ‘defined contribution’ pension savings can do effectively what they wish with their accumulated pot of money, from age 55.3 Ten years on from the start of auto-enrolment into pensions, ten times more people are saving into defined contribution pension schemes than a decade ago.4

 

While tax relief is usually given on money saved into pensions and investment growth is tax free, tax will likely have to be paid when money is taken out. Some of the knock-on effects can be unexpected and, without careful planning, can leave people with less money than anticipated.

 

Kelly Sizer, Senior Technical Manager for LITRG, said:

 

“We urge people not to rush into making decisions about pension withdrawals without fully exploring the tax5 and other consequences of their actions, including impacts on welfare benefits.

 

“We know of people who have received very large tax bills, often unexpectedly, since pension flexibility began. For example, in households where there is a child benefit claim in place, tax charges can include a high income child benefit charge6 when a pension withdrawal pushes the person’s adjusted net income over £50,000. This also means the taxpayer must notify HMRC they are liable for the tax and fill in a Self Assessment tax return.

 

“People should plan ahead where possible. They might pay less tax on money from pensions if it is taken in stages, spread out over a number of tax years, or withdrawn after they have stopped work. For those on lower incomes, tax credits and benefits impacts also need consideration – for example, the taxable element of pensions is also taken into account as income for tax credits.

 

“Think about the future. If you are looking to take money out of a pension to get you through a spell of financial difficulty, you might wish to pay into a pension again in future if the squeeze on your income eases. However, once you have taken pension benefits under the pension flexibility rules, future tax relief is restricted such that you are limited to paying in £4,000 gross a year,7 which is a possible tax trap to beware of.

 

“LITRG’s website guidance8 aims to help people understand the potential issues when taking flexible pension withdrawals. And for those aged 50+, free guidance on pension options can be obtained via the Government’s Pension Wise service.”9