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Do you know the tax rules of pension freedom?

Do you know the tax rules of pension freedom?

Category: Pensions

Updated: 09/04/2015
First Published: 09/04/2015

This article was correct at the time of publication. It is now over 6 months old so the content may be out of date.

The pension freedoms have certainly got everyone excited, with those approaching retirement all clamouring to take advantage of the new flexibilities and make the most of their pension savings. But, before you dive right in, are you sure you understand the tax implications? You may have more freedom when it comes to spending your pot, but that doesn't mean there won't be tax to pay…

Lack of awareness

If you're not fully informed about the potential tax implications, you're not alone. Research from Sanlam has found that a whopping 85% of over-55s surveyed are unaware that they'll face an income tax bill when taking out a cash lump sum, arguing that the Government has failed to communicate the rules sufficiently.

This particular freedom is one that's garnered a considerable amount of interest, but it also seems to have led to the most confusion – 33% plan to withdraw considerable sums from their pot, despite not knowing how much tax they'll have to pay, suggesting that many could be in for a shock.

"The majority of consumers feel annoyed at having paid high tax bills throughout their working lives and appear to be unaware that taking out a cash lump sum from their pension pot could leave them with less than expected in their pocket," said Alex Morley, CEO of Sanlam Wealth Planning.

Know your tax status

Knowing how much tax you'll have to pay should you take advantage of the freedoms will not only ensure that it comes as less of a shock, but it could even help fuel your decision about how to secure a retirement income.

Additional research from Aegon found that 35% of over 55s don't even know which tax bracket they fall into, and a similar amount (36%) aren't aware of the tax implications of accessing their pot. But, once they were aware of the financial repercussions, one in six said they would reconsider taking a lump sum.

It's important to thoroughly consider all the options, and you need to be fully aware of the tax implications and associated risks of withdrawing your pot. While 25% of the pot can still be withdrawn tax-free, the remaining 75% will be subject to income tax. Remember, because this counts as income, if you've got a particularly large pot it could push you into a higher tax bracket – and that means you could end up paying thousands of pounds more to the taxman than you intended.

Of course, you'll need to pay tax no matter how you decide to secure an income in retirement (it's all classed as income, after all), but this particular route has the potential to give quite a shock. Even though most of those planning to withdraw the cash would save it rather than spend it – 31% of Aegon's respondents would put the money into an ISA and 23% would put it into a bank account – it could be more tax-efficient to keep the money invested and opt for a different income solution. This will depend entirely on your circumstances, however, which is why it's so important to understand the options.

Contact Pension Wise for a thorough overview of the options and what the tax implications could be, or for a more tailored approach it'll be worth speaking to a professional financial adviser. However you go about it, make sure you know what you're getting into, and hopefully you won't have an unexpected tax bill to contend with!

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.