Early pension withdrawals create tax confusion for savers

People accessing their retirement savings under the new pension reforms are being caught out by unexpected taxes and welfare reductions, according to research from Citizens Advice, despite warnings from the government that there would be a tax-free limit on the amount of drawdown income

The survey of 500 people aged over 55 who accessed their defined contribution (DC) pensions after April 2015 found that nearly one in ten (9%) had unforeseen tax problems, rising to 30% among people who took their whole pension pot in one go.

From 6 April 2015 savers could take money direct from your pension pot without having to buy an annuity or put the money into drawdown, but only 25% of this sum is tax free. This is called an ‘uncrystallised funds pension lump sum’ (UFPLS).

The research also found that 6% of people using the freedoms faced unexpected issues with their benefits, such a reduction in welfare payments. This is a particular problem for people with lower pension savings, with 11% of people with pension pots worth less than £20,000 reporting unexpected issues with their benefits.

Of those who experienced tax or benefit problems after withdrawing pension funds early, two thirds (64%) managed to get these resolved and the majority (87%) said this was easy to do.

The Citizens Advice’s Life after pension choices report found over a third (35%) of people said the new pension drawdown facility had directly improved their retirement prospects, with the (77%) suggesting this is because they have more control over their money.

However, the survey findings indicate that some individuals are at risk of running out of pension funding.

Citizens Advice found that 29% put any pension withdrawals into a bank account, with the same proportion using the money to pay for daily living costs. One in six (16%) used the cash to pay off debts, and only 18% made further investments.

Gillian Guy, chief executive of Citizens Advice, said: ‘The pension freedoms are popular with consumers but some people are experiencing unexpected losses.

‘In a minority of cases people are being caught out by unexpected consequences of using the pension freedoms, such a being hit by tax deductions or a cut to their benefits.

‘As people’s pension choices become more complicated government and providers need to continue their work to promote free Pension Wise guidance, ensuring people are fully informed about their options as they move from work into retirement.’

Citizen Advice’s research indicated an appetite for pensions advice, with a third of respondents (33%) saying guidance would help them navigate their choices, and a quarter seeking either product comparison (26%) or financial advice (25%).

There was support for this view from Steve Webb, who was the LibDem pensions minister in the Coalition when the reforms were announced, and is now director of policy at Royal London pensions company.

‘If pension savers are putting their money into a bank account on a temporary basis before reinvesting it, then there is less to worry about. But if they simply leave their money in an account paying little or no interest, they will see its real value decline year-after-year through inflation,’ Webb said.

The government is also giving people the right to sell income from their annuities from April 2017, subject to agreement from their annuity provider.

Essential reading

To find out more about the tax implciations of early drawdown read our pensions expert, Gareth Rose, consultant at Rowanmoor

Pat Sweet |Reporter, Accountancy Daily [2010-2021]

Pat Sweet was the former online reporter at Accountancy Daily and contributor to the monthly Accountancy magazine, pub...

View profile and articles

Be the first to vote

Rate this article

Related Articles