Experts warn that there’s “a big cost” to not considering tax when individuals access their pensions.
Between October 2022 and March 2023, hundreds of over 55s were hit – resulting in a tax bill of at least £97,500, because they didn’t know better, new research has shown.
Nearly a decade after the introduction of ‘pension freedoms,’ new research from Standard Life, part of Phoenix Group found that 33 per cent of those aged 55+ are unsure about how pension withdrawals are taxed, and just 29 per cent feel confident in their knowledge.
This is kind of ironic as pension freedoms were introduced to give people flexibility in how they access their retirement savings, but 29 per cent of people say they still lack confidence in their retirement savings choices, with only 32 per cent feeling they fully understand their options.
However, experts are “concerned” with these statistics as not knowing all the options can lead to an unexpected hefty tax bill when trying to access one’s own money.
Standard Life analysis of FCA data found that more than 221 people fully withdrew a pension pot of £250,000 or more between October 2022 and March 2023, resulting in a tax bill of at least £97,500.
Mike Ambery, Retirement Savings Director at Standard Life, part of Phoenix Group said: “Many people understandably don’t think about how much tax they’ll need to pay from their pension income, however it’s important to bear in mind especially when it comes to the critical moment of accessing pension savings.
“Withdrawals are a complex area and if you are unable to access financial advice, it’s worth using the government’s free Pension Wise guidance service or speaking to your provider for the more complex questions. There can be a big cost to not considering tax when you access your pension, up to £97,500 for some.”
This research coincides with the Government and Financial Conduct Authority’s consultation on improving support for those without financial advisers.
The proposed ‘targeted support’ approach would allow pension providers to explain what people in similar positions typically do when faced with a similar set of circumstances.
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Ambery continued: “It’s concerning that nearly ten years after people with a Defined Contribution (DC) pension were given more choice in how to access their money as part of ‘pension freedoms’, so many people feel confused about their options.
“Providers have a big role to play in making communications as clear and targeted as possible, and greater access to personalised guidance is key.
“We want to be able to help people make good decisions and if implemented properly the targeted support solution could help us steer people towards the right outcomes for them.
Catherine Sermon, Head of Public Engagement at Phoenix Insights, highlights that many people face complex retirement decisions with little knowledge or support. She warns that without professional advice, they risk making choices that may not be in their best interest.
Sermon suggests that offering more tailored support could bridge the gap between professional advice and free guidance.
Phoenix Insights has launched a public engagement program to explore perspectives on targeted support, focusing on consumer choice, protection, and best interests in accessing defined contribution pensions.
Ambery explained several options to access the money in their pension pot:
- Take some or all of your pension pot as a cash lump sum – beware of that tax charges might apply to significantly reduce the money you receive
- Buy an annuity – an annual income that will be paid to you for the rest of your life. There are many types of annuity available to buy – you should shop around to find the best one that suits you. It’s possible to use part of your pension to buy an annuity, securing a level of income, and leave the rest to access flexibly
- Take money directly from the pension fund, and leave the rest invested (income drawdown)
- A mix of these options
Individuals can withdraw their entire pension pot as cash, with 25 per cent tax-free, while the remaining 75 per cent is taxed as income.
They can also take smaller sums, with 25 per cent of each sum being tax-free. Any taxable withdrawals are added to other income for the year, possibly pushing them into a higher tax bracket.
When taking a flexible income (drawdown) or annuity, the tax paid depends on the individual’s tax band. Drawdown allows for regular income that can be started, stopped, or adjusted, while an annuity provides a fixed regular income with limited flexibility.
The state pension is taxable, but tax is not deducted from it directly. Instead, tax is taken from other income sources if the total income exceeds the personal allowance, which is £12,570.
The full new state pension is just over £11,500 in the current tax year, which is less than the standard personal allowance of £12,570. So, this won’t be taxed, but it does count as part of one’s total annual income. From April 1, 2025, the state pension will increase by 4.1 per cent, reaching £11,975 per year.
