Martin Lewis pension warning over mistake that could cost you £22,500 in your golden years
MARTIN Lewis has issued a pension warning over a mistake that could cost you £22,500 during retirement.
The founder of MoneySavingExpert.com (MSE) has urged those taking money out of a pension while still paying into it to be aware of the annual allowance.
Speaking on the BBC‘s Martin Lewis Podcast, he said: “One of the issues is if you take money out of your pension, you can reduce the annual allowance, the amount you’re allowed to contribute to your pension in future.”
The founder of MSE was told by Charlotte Jackson, head of guidance at the Money and Pensions Service: “If you take just the 25% lump sum and zero income, that’s the tax-free amount, so there’ll be no impact on your annual allowance.
“But if you start taking income on top of the tax-free cash from your pension, that could be draw-down or an annuity, whichever method, then your annual allowance will drop down to £10,000 from a maximum of £60,000 at the moment.”
For example, if you were to lose £50,000 of your tax-free pension allowance, you’d suddenly be looking at a tax bill of £10,000 on £50,000 for a basic rate taxpayer.
If you’re a higher rate taxpayer, that’s £20,000, and an additional rate taxpayer pays £22,500.
Martin added: “So that’s really worth being aware of.
“If you’re going to start taking money out of your pension but you might want to contribute to your pension in future, that’s the big nodal point where you’ve changed the status of your pension and you’ve reduced the amount you can contribute.”
Most personal pensions set an age when you can start taking money from them. It’s not normally before 55.
Contact your pension provider if you’re not sure when you can take your pension.
You don’t have to access your pension until you reach this age.
If you already have enough income to live on, you might be able to delay taking income from your pension.
This might be because either you’re carrying on working or have other income from savings or investments.
What is the annual allowance?
YOUR annual allowance is the most you can save in your pension pots in a tax year (6 April to 5 April) before you have to pay tax.
You’ll only pay tax if you exceed the annual allowance, which is £60,000 this tax year.
Your annual allowance applies to all of your private pensions if you have more than one.
However, as soon as you take a lump sum from your pot, this affects how much you can continue to save for retirement.
The annual allowance falls to £10,000.
If you want to carry on building up your pension pot, this option might not be suitable.
Options for taking money out your pension
You can usually take up to 25% of the amount built up in any pension as a tax-free lump sum.
The most you can take is £268,275.
The options you have for taking the rest of your pension pot include:
- Taking all or some of it as cash
- Buying a product that gives you a guaranteed income (known as an “annuity”) for life
- Investing it to get a regular, adjustable income (sometimes known as “flexi-access drawdown”)
Ask your pension provider which options they offer (they may not offer all of them).
If you do not want to take any of their options, you can transfer your pension pot to a different provider.
Your pension provider will take off any tax you owe before you get money from your pension pot.
Withdrawing as cash
You may be able to take cash directly from your pension pot.
Your options include the following:
- Withdraw your whole pension pot
- Withdraw smaller cash sums
- Pay in – but you’ll pay tax on contributions over the money purchase annual allowance
Remember, you can usually only take up to 25% of the amount built up in any pension as a tax-free lump sum though.
Buying annuity
You might be able to buy an annuity from an insurance company that gives you regular payments for life.
You can ask your pension provider to pay for it out of your pension pot.
The amount you get can vary.
It depends on how long the insurance company expects you to live and how many years they’ll have to pay you.
When they calculate the amount they should take into account:
- Your age and gender
- The size of your pension pot
- Interest rates
- Your health
There are different kinds of annuities.
Some are for a fixed time (for example, payments for 10 years instead of your lifetime) and some continue paying your spouse or partner after you die.
You do not have to buy your annuity from your pension provider.
Investing into a drawdown
Flexible retirement income is often referred to as pension drawdown, or flexi-access drawdown and is a way of taking money out of your pension pot to live on in retirement.
It can give you more flexibility over how and when you receive your pension.
You can take up the 25% of the pot as a tax-free lump sum and the rest of the pot remains invested, giving it the potential for investment growth.
You can then decide if you want a regular income, or amounts as and when you need them.
The value of your invested pot can go down as well as up, which means the income isn’t guaranteed and you could run out of money.
What are the different types of pensions?
WE round-up the main types of pension and how they differ:
- Personal pension or self-invested personal pension (SIPP) – This is probably the most flexible type of pension as you can choose your own provider and how much you invest.
- Workplace pension – The Government has made it compulsory for employers to automatically enrol you in your workplace pension unless you opt out.
These so-called defined contribution (DC) pensions are usually chosen by your employer and you won’t be able to change it. Minimum contributions are 8%, with employees paying 5% (1% in tax relief) and employers contributing 3%. - Final salary pension – This is also a workplace pension but here, what you get in retirement is decided based on your salary, and you’ll be paid a set amount each year upon retiring. It’s often referred to as a gold-plated pension or a defined benefit (DB) pension. But they’re not typically offered by employers anymore.
- New state pension – This is what the state pays to those who reach state pension age after April 6 2016. The maximum payout is £203.85 a week and you’ll need 35 years of National Insurance contributions to get this. You also need at least ten years’ worth to qualify for anything at all.
- Basic state pension – If you reach the state pension age on or before April 2016, you’ll get the basic state pension. The full amount is £156.20 per week and you’ll need 30 years of National Insurance contributions to get this. If you have the basic state pension you may also get a top-up from what’s known as the additional or second state pension. Those who have built up National Insurance contributions under both the basic and new state pensions will get a combination of both schemes.
Do you have a money problem that needs sorting? Get in touch by emailing money-sm@news.co.uk.
Plus, you can join our Sun Money Chats and Tips Facebook group to share your tips and stories