Recent research from Prudential has found that one in ten people planning to retire this year intend to withdraw their entire pension savings as one lump sum. This suggests many people could be unaware of the tax bill they will face for doing so, and may also be discounting the risk of running out of money later in retirement.
The first thing to note is that when taking a pension as a lump sum only the first 25% is paid out tax-free, the rest is taxable as income. If someone with a £100,000 pension withdraws the whole fund, they will receive £25,000 tax-free but £75,000 will be taxable. Even if they have no income from any other sources, this would result in tax of around £18,000 being deducted from the payment. Some people may receive significantly less than expected from their pension as a result.
The study found that the main reason given for taking the fund in one go was to invest elsewhere such as a savings account, property or investments outside of a pension. None of these investments will enjoy the tax benefits of a pension, which include tax-free growth and income and exemption from Inheritance Tax. Again, it may be that people are unaware of the amount of money they could lose to tax through this course of action.
Of those intending to spend rather than invest the money, 34% are planning holidays and 25% home improvements. Other popular uses include gifts to children or grandchildren, buying a car or paying off a mortgage. The study does not comment on whether these individuals have secure pensions or other sources of wealth elsewhere, in which case these funds may be surplus to requirements. If not, they face not only a large tax bill but could also be risking their long term financial security in retirement in return for short term benefits.
A pension represents a lot of hard work and saving, and savers will want to benefit from this to realise some of their retirement dreams. We would urge all those approaching retirement to access their pension in a way that minimises the amount handed over to the taxman, and benefits both their long and short term aims. For help finding the perfect solution, please contact us for financial advice. Please note this article does not constitute personal financial advice. The value of tax benefits depends on individual circumstances and tax rules are subject to change by the government.