Five reasons not to withdraw your pension cash

A recent survey found people are withdrawing their pension savings and depositing them in bank accounts. But by doing so they could face unexpected tax charges.
Facebooktwittergoogle_pluslinkedinmailFacebooktwittergoogle_pluslinkedinmail   by Jeannie Boyle, 16th September 2016

A study published by Citizens Advice has shown people accessing their retirement pot under the new pension freedoms are simply depositing their cash straight into low interest bank accounts.

The survey found just under 30% were taking this option even though they had no immediate plan for using the money.

Apart from the loss of returns, pension withdrawals can have significant tax implications. Here are five key reasons why it’s better to keep the money in your pension unless you actually need it:

1. Income tax

Once you’ve taken the 25% tax-free lump sum, any further withdrawals are added to your income to assess how much tax should be paid. If you’re still earning a salary you could easily find yourself paying 40% or even 45% tax on your pension money. Spreading your withdrawals over several years can help reduce the tax paid.

2. Emergency tax

In many cases HMRC applies ‘emergency tax’ to the payment. This means they assume you will be receiving the same payment every month and tax you accordingly. It’s up to you to then reclaim the extra tax paid.

3. Low interest rates

Rates are currently so low the value of your money will be eroded by inflation. As at July 2016, the Retail Price Index was running at 1.9%, whereas the average Cash ISA now pays 0.99%. At these rates £100,000 would be worth £91,420 after 10 years, reducing the income available to you in retirement. The Bank of England’s decision to cut interest rates to an all-time low of 0.25% in August is likely to see saving rates fall further, meaning even lower returns.

4. Inheritance tax (IHT)

Money in a pension is usually exempt from IHT. If you withdraw the money without spending it, your loved ones may pay 40% tax after your death. If the money stays in your pension your family will pay no tax if you die before age 75 and their own rate of income tax if you die after age 75.

5. More income tax

If the interest you receive each year exceeds £1,000 (or £500 if you are a higher rate taxpayer) it will be taxable whereas there is no tax to pay on interest payments whilst the money is invested in a pension.

While the pension freedoms have provided a wealth of new opportunities, it is vital that you consider absolutely every option before committing to one.

 

Many people opt for cash over investment because they feel uncomfortable with investment risk, particularly in the approach to retirement. If you feel more comfortable with cash (despite the effects of inflation) it’s important to remember this option is available without taking the money out of your pension.

Most pension providers offer the option of a cash fund (a mix of different deposits and other cash like investments) which allows you to reduce investment risk without the need to withdraw the money.

If you have a self-invested personal pension (SIPP) you will be able to select from a range of deposit accounts. Using the cash options available from your pension provider means you don’t have to withdraw the money until it’s actually needed.

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About the author: Jeannie Boyle

Jeannie has been working in financial services for over 10 years. She joined EQ in 2008 as a Technical Consultant and since 2010 has been a Director of the firm. When providing advice, Jeannie focuses on clear communication, so that her clients fully understand the facts, options and recommended solutions, enabling them to make well-informed decisions. As a Director, Jeannie concentrates her efforts on ensuring the advice provided across EQ is of an exceptional standard, putting in place processes and systems to ensure our clients remain at the heart of our business. Jeannie is a Chartered Financial Planner and in 2015 won Money Management’s Ethical Financial Planner of the Year Award. She appears regularly in national and trade media outlets discussing personal finance issues. Outside of work, Jeannie enjoys yoga, hiking, triathlons and live music.

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