Personal finance wizard Martin Lewis has given a stern warning that people who perform a certain action with their pensions could be making a big mistake and paying lots of tax on their own money. Speaking on his ITV show this week, Mr Lewis was speaking out about the changes which were brought in by then-chancellor George Osborne to allow people to take money out from the age of 55.
This has proved controversial with concerns raised about people being left without enough to live on in their retirement. Mr Lewis said that the rules were changing so that from April 2028 people have to be over the age of 57 to take the money out.
He warned: “If you do do this, it can reduce what you can put in later once you take the income. Now 25% of the money that you take out is tax free. The rest is taxed at your marginal rate. What does that mean? It means if you’re a basic rate taxpayer, of course there’s always a bit you don’t pay tax on, your personal allowance, but it’s 20%. If you’re a higher rate taxpayer, it’s 40%. That’s what you’re going to be taxed on.”
Mr Lewis explained that contrary to what some thing the key thing to remember is that you’re not taking out the whole sum tax-free. He said: “So if you take £10,000 out of your pension fund, £2,500 of that will be tax free. And the remaining £7,500 of it… you will pay tax on at your marginal rate that tax year. So you can’t just take it all out tax-free.”
And he said that there was an alternative way of accessing the cash: “There is an alternative way of doing it. If you take 25% out and put the rest in an income drawdown or annuity ou can choose to just take 25% tax free and leave the rest in an annuity or an income drawdown so that it is taxed at the point you access that amount of money.
“So why is this important? Well, let’s contrast it here. Move on, please. Here you go. If you just take it out, imagine that right now you’re a higher 40% rate taxpayer. And at a later date, once you retire, you’re not going to have as much income, you’d be a 20% rate taxpayer. So you take your £10,000 out right now, your £7,500 of it is taxed at 40%, but if you could wait with it, it’d be taxed at 20%, so less tax would be paid.
“But if you do it this way, you can take all the tax-free, all the jam, all the sugary sweet, lovely bit out now. And you can wait until later on when your income drops down and you’re not as high a rate taxpayer to take the rest out so that you’d only be paying tax at 20%, not 40%, the same would work if you’re dropping from 20% to a non-taxpayer or higher.
“So the advantage of doing it this way is especially strong for those people who may pay tax, income tax at a lower rate later on because they have less income. And you can see why I’m saying you get this wrong, this could be thousands or tens of thousands of pounds difference that you’re unnecessarily paying, so please get guidance on that.”