The ability to access your pension early opens a whole world of opportunities.
But just because you can, doesn’t always mean that you should.
And, if you do, there are pitfalls and mistakes that you need to be aware of, to make sure that you don’t fall foul of any expensive taxes or run into financial difficulties in later life.
So, what should you look out for?
Predicting the future
78% of over-50s underestimate their life expectancy. (Source: Retirement Advantage)
Both men and women aged 50-64 think that they will live to be around 82. However, current life expectancy for this age range is:
- 88 for men
- 90 for women
This means that almost eight out of 10 people are at risk of running out of money during the first half of their retirement years, due to a lack of financial planning for the later years.
Too much, too soon
Taking too much out of your pension fund may leave you with little to work with in your later years. That will leave you facing financial difficulties and could mean that you don’t have enough money left to pay for necessary medical or care costs.
According to Prudential, many older people put off thinking about the need to save for health and social care in later life, with:
- 54% (wrongly) believing that accessing social care is free at the point of service
- 47% of 50-64-year-olds expecting to need to pay for long term care
- 4% of those aged 65+ factoring long-term care into their financial planning
With the average nursing home fee breaching £1,000 per week, leaving the costs of living comfortably in later life, to chance, is simply not worth the risk. (Source: Lang Buisson)
Before you take any money out of your pension fund, you need to be sure that you know how it will be taxed.
You can take up to 25% of your pension fund as a tax-free lump sum. Any further withdrawals will be added to your existing income and may be subject to tax.
For withdrawals of less than £10,000, HM Revenue & Customs (HMRC) will charge tax of 20%, and if you find that you are under the personal allowance of £11,500 (£11,850 from April 2018), you are able to claim a refund on that.
The bigger issues are when withdrawals of lump sums of more than £10,000 are made. The process by which HMRC claims tax, can lead to the assumption that you will make the same withdrawal each month. By predicting an annual income which falls within the higher and additional rate tax bands, you will be charged 40/45% tax.
Of course, you can claim a refund for overpaid tax, but if you are planning to make a big purchase, losing that 20/25% straight away, may be an issue. To ensure that this doesn’t happen to you, it is vital that you talk to your provider and find out how your withdrawals will be taxed before you start to take it.
Wrong place, wrong time
You decide to take money out of your pension fund and hold it in a savings account. If you intended to hold the money long term, then taking this route is almost always the wrong thing to do. It raises two very big issues:
- Depending how much you take out of your pension pot, you may have to pay tax on the money you withdraw
- Savings accounts such as ISAs consistently provide interest rates which are lower than inflation, which means that you are losing value in real terms
Once you have lost money to both taxation and inflation, you may find that it would have been better to keep the money in the pension fund all along. And once it’s been done, it is almost impossible to restore the lost capital.
Think of the children!
Let’s talk inheritance. It’s not nice to think about leaving your partner and children behind, but it can bring peace of mind to know that they will benefit from the assets and money you leave for them.
Capital which is held in pension pots is usually free from Inheritance Tax (IHT). If you die before the age of 75, it is also free from Income Tax. If you reach your 75th birthday before passing away, your beneficiaries will pay Income Tax on any income or lump sums they receive.
Therefore, it is best to leave any money you do not need to spend, in your pension pot until it becomes more efficient to withdraw it.
There must be an easier way?
There are a lot of factors to consider when withdrawing money from your pension fund, and the above list is not exhaustive. Your own priorities and circumstances may reveal more pitfalls or opportunities.
The answer is financial planning and advice. An independent financial adviser will be able to offer products and methods which suit your needs and dreams for the future.
To find out more, please get in touch with us on 01664 77 88 99.