For years now, those approaching retirement have been warned about how their benefits are being placed at risk in instances where they look to make early withdrawals. Even former Prime Minister David Cameron discussed this issue ahead of the 2015 election, as he vowed to protect pensioner benefits and the integrity of individual plans.
If anything, the situation has arguably worsened since this time, with pension experts and city watchdogs having recently reaffirmed that unwary retirees may be taxed heavily for withdrawing lump sums from the pension pot upfront.
So should you prepare for this as you retire, and how can you look to avoid paying a high tax burden? Let’s take a look:
How Can Lump Sum Withdrawals Impact Taxation?
For generations, the default option for pensioners has been to make an early, lump sum withdrawal that accounts for 25% of their fund. While this has historically delivered a number of advantages that can only come courtesy of a large, cash windfall, new legislation passed in 2015 has changed the financial landscape and offered far greater flexibility to applicants. So while pensioners can still withdraw an initial 25% lump sum from their fund, this is no longer the single most tax-efficient way of leveraging your capital.
Instead, you now have the option to keep your capital invested in a fund for longer, while taking 25% tax-free every time you make a withdrawal in the future. According to various studies that have been conducted since, savers who refuse to take their lump sum early could end up £64,000 better-off over the course of their retirement, while they may also pay considerably less tax and enhance the underlying value of their fund.
Making the Most of Your Wealth: The Issues and How to Overcome Them
It is estimated that nine in ten retirees with defined contribution pension plans took out lump sum withdrawals prior to 2015, while this remains a popular practice to this day. Awareness is a crucial weapon when managing your finances, however, and it is important to remember that after withdrawing a lump sum any subsequent income is taxable at the normal rates of 20%, 40% and 45%.
The recent reforms make it far more efficient to remain patient and make regular tax free withdrawals, however, and understand this is crucial to enjoying a relaxing retirement.
You also need to make proactive and practical adjustments to your plans, firstly by seeking out expert advice from a reputable finance and wealth management outlets such as Tilney. You can also seek assistance from the government’s complimentary ‘Pension Wise’ advisory session, which is being delivered in person and over the phone in conjunction with the Citizens’ Advice Bureau.