RETIREES are being warned to check before cashing out pension pots as if they plump for the wrong one they could see their savings slashed by up to 90 per cent.
The problem affects those with more than one pension pot, which is easily done if you’ve had multiple jobs in your life, who want to withdraw more than 25 per cent.
Now, this is a little complicated, so bear with us, but it all comes back to the so-called pension freedoms introduced in April 2015.
This saw savers aged 55 or above able to withdraw cash from their pensions in lump sums for the first time.
Under the rules, the first 25 per cent you take from each pot is tax-free while the rest is taxed at your usual income tax rate – 20 per cent for basic rate taxpayers, 40 per cent for higher rate earners and 45 per cent for additional rate taxpayers.
Prior to this, retirees had to turn their pension pot into an annual income for life using an annuity or keep their pension invested and use something called income drawdown to access it.
There is a catch though – if you take more than your 25 per cent tax free allowance from a pot of £10,000 and above then you’re limited to only adding an extra £4,000 back into it.
This is under rules known as the Money Purchase Annual Allowance (MPAA).
But this £4,000 limit is a whopping £36,000 – or 90 per cent – less than the £40,000 a year limit you’re allowed to put into an untouched pension.
To get around this, former pensions minister Steve Webb, who’s now director of policy at financial provider Royal London, advises taking cash from pensions of £10,000 and under first.
What are the different types of pension?
WE round-up the main types of pension and how they differ:
- Personal pension or self-invested personal pension (Sipp) – this is a pension you can set up on your own where you can pick the provider and choose how much to invest.
- Workplace pension – if you’re an employee it’s likely you’ll have been auto-enrolled into a workplace pension. The pension provider is usually chosen by your employer and you won’t be able to change it – but you can always try speaking to your HR department if you think employees would benefit from a different scheme. With workplace pensions, both the employee and employer have to pay in a combined minimum of 8 per cent.
- New state pension – this is what the state pays to those who reach state pension age after April 6 2016. The maximum payout is £168.60 a week and you’ll need 35 years of national insurance contributions to get this. You also need at least ten years’ worth of national insurance contributions to qualify fullstop.
- Basic state pension – this is what the state pays to those who reached state pension age on or before April 6 2016. The full basic state pension is £129.20 per week and you’ll need 30 years of national insurance contributions to get this. If you have the basic state pension you may also get a top-up from what’s known as the additional or second state pension.
And those who want to take more cash than they’ve got saved in smaller pots, should use the smaller pots first to minimise the amount they withdraw from the larger pot in an attempt to avoid the MPAA trigger.
He uses the example of someone with a £4,000 pot and a £20,000 pot who wants to withdraw £9,000 in total.
Here, they’re better off cashing in the smaller pot and taking the remaining £5,000 from the larger pot as the MPAA won’t be triggered as it’s within the 25 per cent limit.
In contrast, take all the cash from the larger pot and you go over the 25 per cent tax-free limit of £5,000 meaning the MPAA takes force.
While you may think you won’t have more than £4,000 a year to stick into your pension anyway, it could become handy if you come into unexpected cash.
Mr Webb said: “Last year, over half a million people aged 55 or over made flexible withdrawals from their pension, and many of these withdrawals will have been for amounts under £10,000.
“If they emptied out a small pot then this will have had no impact on their future ability to save into a pension.
“But if, by mistake, they took the same amount as a partial withdrawal from a bigger pot, they risk triggering stringent HMRC limits on future pension saving.
“Those with more than one pension pot should consider very carefully the order in which they access these funds, especially if they may want to contribute into a pension in future.”
But one retired couple may have to sell home of 40 years due to a little-known pension rule.
And if you’ve got a pension, make sure fees don’t reduce your savings pot by hundreds of thousands of pounds.
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