The new freedoms set to grace the pensions landscape have been widely applauded by savers and the industry alike. Those approaching retirement will have the flexibility to access and spend their pension pot as they wish, without being subject to such prohibitive tax charges as under the current system, and according to research, a lot of people will take advantage of that flexibility to cash in the lot.
Figures from Hargreaves Lansdown have revealed that 12% of those with defined contribution pensions are planning to take their pension in one go when they have the freedom to do so next year. According their calculations, this equates to around 200,000 people.
Of those, 22% plan to use the cash to live on and 13% would use it to pay off debts, while others have more frivolous ideas, such as holidays (21%) or DIY (12%). Then there are some that want to be in control of their finances and see if they can make successful investments, with 16% planning to reinvest their pension into property.
However, no matter what they decide to spend it on, it can't be denied that a substantial number of people are choosing to withdraw the lot. And, with some 200,000 savers going down this route, it could result in a significant sum of money heading to the Treasury.
Despite there being fewer restrictions surrounding accessing your cash, there will still be tax charges to pay. The first 25% of your pot can be withdrawn entirely tax free, but the remainder will still be subject to income tax. And, if your pot is substantial and/or you're still receiving an income, the tax charge could be higher than you were expecting.
Hargreaves' calculations show that, should those 200,000 people decide to cash in their pot, the amount of tax the Treasury would receive could be as much as £1.6bn, based on the average pension pot value of £29,000 and a higher rate of tax being applied. It's a complex calculation and the ultimate figure will depend on individual pot sizes, incomes, personal allowances and tax-free lump sum entitlements, but in a nutshell, the Treasury could receive a huge amount – potentially without savers even realising.
The research highlighted a clear lack of awareness regarding the tax implications of cashing in pension pots, with just 38% of those surveyed able to accurately state how much tax would be deducted from a medium-sized pot. This figure falls to 6% when asked to predict the tax implications of a large pension pot – a significant cause for concern, as it shows that a large number of savers are unaware of how much tax will be deducted from their savings should they take advantage of the new freedoms.
Tom McPhail, head of pensions research at Hargreaves Lansdown, commented on the findings: "Whilst we support the basic principles behind the Government's reforms, a lot of investors are going to be paying unnecessarily large amounts of tax.
"There is an urgent need for the Government to think again about how to effectively regulate these new freedoms. We want investors to take responsibility for and to engage with their savings, but we also don't want then paying unnecessary tax bills or running out of money."
This is why it's so important to familiarise yourself with the changes, and ideally, get expert advice to help. It's a highly complex area and the new flexibilities make it even more important to be prepared, both so you're aware of the tax implications and to ensure you use your pot wisely. There'd be nothing worse than withdrawing more than you should only to find you exhausted your income stream in later life, so making the right choices now is key.
Consult our annuity planner to consider your options
Disclaimer: Information is correct as of the date of publication (shown at the top of this article). Any products featured may be withdrawn by their provider or changed at any time.
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