Tax warning: Britons ‘cashing out’ their pensions could end up paying more

Pension: Expert explains consequences of ‘cashing out’ retirement pot

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When a person retires, they may be able to cash in on some of their pension pots – depending on which one it is – and receive all the money they have saved over the years. However, this may not be the best idea.

On the AJ Bell Money and Markets podcast, Tom Selby discussed the consequences of this if once may choose to do it. He argued “just because you can do something, doesn’t mean that you should.”

He said: “Cashing out your entire retirement pot as soon as you can comes with various health warnings.

“Because 75 percent of your withdrawal is taxed in the same way as income with a quarter being tax free, on that 75 percent, you might push yourself into a higher tax bracket and pay more to the tax man than is necessary.

“If you’re taking out say £50,000 or £60,000 then you may push yourself into paying 40 percent tax.

“But if you drip feed it, you could pay 20 percent tax, or even no tax at all if it’s within the personal allowance.”

Furthermore, Brits may trigger the Money Purchase Annual Allowance if they cash out their entire pension pot.

Mr Selby went on to discuss what the MPAA is.

He said: “That means that the maximum you can save each year in a pension will fall from £40,000 to just £4,000.

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“So, you’ll be restricting your ability to build up a pension if you take taxable income from your pension pot.”

Moreover, Mr Selby stressed the fact that before withdrawing any pension funds, Brits should know where they are putting their money and how it will be affected in today’s market.

He added: “You also need to think about the fact that you’re going to be moving your money from a world where Capital Gains Tax and Inheritance Tax don’t usually apply to one where they do.

“In fact, one of the biggest problems with people cashing out pensions is that they shove their money into bank accounts that are paying little, or no interest.

“That money could be eaten away by inflation.”

Defined contribution pensions are also now extremely tax efficient on death and can be inherited tax free if you die before age 75.

Contrastingly, if you move it out of a pension that money is likely to be subject to Inheritance Tax and form part of your estate.

Another consequence one may face if they cash in their pension too early is struggling later in their lives.

Mr Selby said: “If you take out your pension too early, how will you fund your later life.

“If someone is aged 55 for example, they might have 40 years or more to live and so if they cash out all the money now, or spend it all now, they need to think about what’s going to be left when they’re in their 80s, or 90s.”

The state pension is an income given weekly by the government so there is no mechanism there to cash it all out at once.

For men and women, this is currently 66, however the state pension age is scheduled to rise to 67 between 2026 and 2028

Defined contribution pensions can be accessed from age 55 with a quarter of this available tax free and the rest taxed like income. These are pension pots that are invested into assets such as stocks and bonds.

Once a person reaches age 55, they have total flexibility with how they spend their money but this age could increase in the future.

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