You may have saved a lot to lead a comfortable life in retirement. You may have also successfully dodged all the pension scammers that never gave up on trying to reach you on your phone.
You have certainly worked hard all your life to put together the fund that you have right now and ideally this fund should be in a place where it can be easily accessed, earns you a high rate of growth and is also protected from tax.
But one wrong move can put this fund where it doesn’t earn even half the interest that it should makes you pay hundreds or even thousands of pounds to the tax man, a sum that you could have easily saved.
Following are certain pitfalls that you need to look for:
Grab the Cash and Run?
Royal London conducted a survey in which it found that nearly 70 percent of the 800 that were surveyed wanted to cash in their entire pension amount in one go. Under pension freedom it is possible to do such a thing. But is it advisable to do anything which is possible? Would you ever get off your car on a motorway and do a moonwalk on the fast lane? It is possible but advisable, not really.
The survey also found that 23 percent of those who intended to withdraw their pension pot were actually planning to transfer the fund into an ordinary bank account. Interest and tax are two major reasons why you shouldn’t make such a move.
Losses on Interest
Pension fund is essentially a savings account which offers unusually high rates of long-term growth. Previously there were heavy restrictions on when and how a person could access their pension fund but now most of these restrictions have been lifted. Putting your pension fund into a bank account comes with severe disadvantages and it is quite similar to trading a sports car for a horse carriage.
The disadvantage which is a lot worse than lower interests is the fact that you need to pay greater taxes. Most people who move their pension fund into a regular bank account are unaware of the amount of taxes that they may have to pay in the process.
According to the rules, out of the whole amount in your pension pot only 25 percent of it can be withdrawn tax free. Withdrawing beyond this limit will attract taxes at marginal rates.
According to the estimates of Royal London, on a pot that is worth £15,000 there may be an initial tax charge of over £3,000. For the entire savings term this sum of money was benefited from tax relief and withdrawing it in one go can render the entire saving exercise meaningless.
How to Reduce Tax on A Pension
This brings us to the question of what is the alternative to the above peril and how one can prevent taxes from burning a hole in their pension fund. To find the answer to this question one needs to understand how tax works.
By staying within the tax-free personal allowance in retirement, it is possible for you to pay little or no tax. Making smaller withdrawals from your pension pot should be able to save you a lot of money as against withdrawing it all in one go.
If your current pension fund doesn’t offer you much flexibility in terms of what you want it is always possible to switch to another pension fund.
The important takeaway from all that we have discussed above is that withdrawing the entire pension amount you are entitled to can result in significant losses. Even though withdrawing from a pension is quite similar to withdrawing from a bank account there is a major difference between these two cases.
The money that you withdraw from a pension pot qualifies as income for the particular tax year and therefore becomes taxable. The money that is kept in a bank account on the other hand has already been taxed and therefore withdrawing it doesn’t make you liable to pay any more taxes.
Another common mistake that most retirees make is that they fail to write a Will to protect their assets despite the common availability of a Will template. This mistake may not affect you directly but can prove to be quite a trouble for those who you leave behind.