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Retirees face shock pension tax bill

New rules which make it easier to take money out of a pension could have a sting in the tail, tax experts are warning.


People who want to take advantage of new flexible pensions rules could end up paying over the odds in tax, experts warn.

From next April, sweeping changes to pensions legislation mean that savers will be able to take money out of their retirement funds at a much lower tax rate than is presently the case.

Quarter of pension tax-free

It is possible at the moment to take a quarter of any pension savings free of tax, and that will not change in 2015.

But any further withdrawals currently face a swingeing 55% tax levy.

From next year, individuals will only be taxed at their marginal rate: 20% for basic-rate taxpayers, 40% for higher-rate taxpayers and 45% for those in the top earnings band.

Investment firm Fidelity Worldwide is warning, however, that anyone who takes a large sum out of their pensions after the rule changes kick in risks pushing themselves into a higher tax bracket.

Most ‘not aware of tax implications’

A Fidelity study has found that only a third of people who were considering taking much or all of their pensions as cash were aware of the tax implications.

Alan Higham, the firm’s head of retirement insight, says: "Our research showed that more than half of the over-60s are planning to take their full pension pot at retirement or are still undecided on what they will do.

"However, only a third had an understanding of the possible tax implications of taking more than their tax free lump sum."

Higham explains that someone who is a basic-rate taxpayer earning £27,000 during the financial year they retire would push themselves into the 40% tax bracket if they took the whole of a £30,000 pension upon retirement.

Paying £1,500 too much

"As a result they would pay over £6,000 in tax whereas by withdrawing their fund over two years, they could save £1,500 of unnecessary tax," he says.

"We urge people approaching retirement to do their homework before they make any decisions.

"And for the pensions industry and government to do more to make people aware of the implications of these at-retirement choices.

"At the very least, providers should be applying a safety net check by getting people to explicitly confirm that they know that any money they take above their 25% tax free lump sum will be added to their income and taxed."

Why take money out of a pension?

The changes to the tax rules are part of a wide range of reforms.

Retirees will no longer be effectively forced to buy an annuity, which guarantees an income for life but which is a contract that generally cannot be reversed.

It will be easier to leave a pension fund invested in the stock market and other assets and to take a regular income from it – a process known as drawdown.

The abolition of the 55% tax rate means that more people are likely to take their pension savings and use them for alternative investments such as buy-to-let property or even classic cars.

A number of studies, however, have found than many of those coming up to retirement are concerned about their money running out – an issue that an annuity can address.

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Chris Torney

Chris Torney

Chris is the former personal finance editor at the Daily Express. He's been a journalist for more than 10 years and contributes to a wide range of finance and business titles.Read more from Chris

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