Pensioners could be hit with hefty tax bills if they withdraw too much from their pot

2nd June 2014

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Pension investors with an average pension pot could find themselves paying 33% tax or £11,867 were they to take advantage of rules allowing them to withdraw a full pension pot from April next year.

Research from MGM Advantage also shows 59% of the over 55s do not understand the tax implications of lump sum withdrawals. The firm says that people who have been used to paying basic rate tax their whole life could find themselves paying 40% tax on at least part of their fund.

The firm has created an online calculator to help people work out tax implications of lump sum withdrawals on the link below – http://www.mgmadvantage.co.uk/calculator/.

The research shows that when the tax implications are explained, people are far more likely (83%) to leave their money in a pension wrapper and draw an income as needed, rather than taking the entire pot as cash in one go. Some 17% say they are happy to pay tax on any withdrawal.

Assuming an average pre-retirement salary of £30,000 and average annuity pot of £35,600 someone would pay around 33% tax (£11,867) if they choose to withdraw their entire pension in the same tax year they were earning.

Andrew Tully, pensions technical director, MGM Advantage says: “The new freedoms proposed by the Chancellor could result in some scary tax bills for those wanting access to all of their pension savings in one go. While increased flexibility is good and something we fully support, there is a huge potential downside and a minefield to navigate. We need to make sure people fully understand the impact of the tax hit if they want access to their pension money in one fell swoop.

“People taking an income over £100,000 could find themselves in an effective 60% tax bracket due to the reducing personal allowance over that threshold. Higher rate taxpayers will of course pay 40% on any withdrawals from their pension pot or even the additional rate of 45% on some of the fund if their total gross earnings exceeds £150,000.”

MGM Advantage has calculated the following example.

Someone earning £30,000 in the year he wishes to retire, who takes the first 25% as tax-free cash, has decided to cash in the rest of his fund. This is what his tax position would look like, given various size pension pots:

Pension fund withdrawal (after tax-free cash) Tax payable on the withdrawal (and effective tax rate)
£90,000 £37,627 (42%)
£75,000 £28,627 (38%)
£37,500 £12,627 (34%)
£22,500 £6,627 (29%)

1. Source: ABI, the average annuity purchase price in 2013 was £35,600, after tax-free cash has been taken.

These figures have been calculated using income tax limits for 2014/15 as follows:

Personal allowance         £10,000

Basic rate limit              £31,865

Higher rate payable        > £41,865

2. Figures assume person born after 5 April 1948 Source: Research carried out online among 1000 respondents aged 45-65 by Onepoll, all who are paying into a pension. 299 people were aged 56-65. Fieldwork was completed 23 May 2014 – 27 May 2014.

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