As of next year, 200,000 people are set to cash in their pension pots all in one go, according to a survey by Ipsos Mori, a leading market research company. From much needed home improvements, to a dream holiday, the relaxation of the UK pensions systems will see savers do as much or as little as they wish with their hard-earned savings. However, the research of 1000 adults with a pension fund also highlighted widespread ignorance on how much tax is payable on such withdrawals.
With the significant reforms to the industry just around the corner, it is important for those in or approaching retirement to understand the full extent of the changes looming and how easily savers could eat into their retirement pot without the right guidance and advice.
From April 2015, individuals over the age of 55 with a pension will no longer have to buy an , which pays a fixed income for the rest of their life. The option to purchase an annuity will still be available; however, pensioners will be able to cash in however much they want from their pension savings and make their own decision on how and where to spend their retirement pot. If someone decides to withdraw a lump sum from their pension, they will receive 25% tax free, with the reminder taxed at their marginal rate.
For example, if an individual has a pension pot worth £100,000, they will be able to take £25,000 (25%) as a tax-free lump sum and either take the remaining 75% immediately and pay income tax at their marginal rate, or consider leaving the remainder invested in a pension, purchase an annuity or adopt alternative investment vehicles.
The increased freedom will provide an array of opportunities for pensioners to boost their retirement income. However, the recent findings continue to highlight the lack of knowledge amongst the over 55s. Experts have predicted that a number of savers will withdraw more than they need, which will ultimately drag them into a higher rate tax band. If the estimates prove accurate, the government could be in line for a tax windfall of up to £1.6bn. If an individual normally pays 20% income tax, they might end up having to pay tax at 40% if the sum withdrawn from the pension takes them over the higher rate tax threshold, which occurs when their taxable income reaches £41,866.
The pension reforms will open a number of doors but it is important for those approaching retirement to think carefully about their options by evaluating the possible risks and benefits of exploring the different avenues available.