Five reasons not to withdraw your pension cash
A study published by Citizens Advice has shown people accessing their retirement pot under the new pension freedoms are simply depositing their cash straight into low interest bank accounts.
The survey found just under 30% were taking this option even though they had no immediate plan for using the money.
Apart from the loss of returns, pension withdrawals can have significant tax implications. Here are five key reasons why it’s better to keep the money in your pension unless you actually need it:
1. Income tax
Once you’ve taken the 25% tax-free lump sum, any further withdrawals are added to your income to assess how much tax should be paid. If you’re still earning a salary you could easily find yourself paying 40% or even 45% tax on your pension money. Spreading your withdrawals over several years can help reduce the tax paid.
2. Emergency tax
In many cases HMRC applies ‘emergency tax’ to the payment. This means they assume you will be receiving the same payment every month and tax you accordingly. It’s up to you to then reclaim the extra tax paid.
3. Low interest rates
Rates are currently so low the value of your money will be eroded by inflation. As at July 2016, the Retail Price Index was running at 1.9%, whereas the average Cash ISA now pays 0.99%. At these rates £100,000 would be worth £91,420 after 10 years, reducing the income available to you in retirement. The Bank of England’s decision to cut interest rates to an all-time low of 0.25% in August is likely to see saving rates fall further, meaning even lower returns.
4. Inheritance tax (IHT)
Money in a pension is usually exempt from IHT. If you withdraw the money without spending it, your loved ones may pay 40% tax after your death. If the money stays in your pension your family will pay no tax if you die before age 75 and their own rate of income tax if you die after age 75.
5. More income tax
If the interest you receive each year exceeds £1,000 (or £500 if you are a higher rate taxpayer) it will be taxable whereas there is no tax to pay on interest payments whilst the money is invested in a pension.
While the pension freedoms have provided a wealth of new opportunities, it is vital that you consider absolutely every option before committing to one. Many people opt for cash over investment because they feel uncomfortable with investment risk, particularly in the approach to retirement. If you feel more comfortable with cash (despite the effects of inflation) it’s important to remember this option is available without taking the money out of your pension.
Most pension providers offer the option of a cash fund (a mix of different deposits and other cash like investments) which allows you to reduce investment risk without the need to withdraw the money.
If you have a self-invested personal pension (SIPP) you will be able to select from a range of deposit accounts. Using the cash options available from your pension provider means you don’t have to withdraw the money until it’s actually needed.
Jeannie Boyle is a chartered financial planner at EQ Investors