Investors need advice on pensions ‘tax bombshell’

Investors need advice on pensions ‘tax bombshell’

Low-income pensioners could face unexpectedly large tax bills if they make use of pension freedoms, a senior wealth adviser for national law firm Bond Dickinson has warned.

Greg Moss warned that many people had no idea of the tax implications of cashing in their pension fund.

The firm claimed there were pitfalls in the detail of the rules, which were introduced on 6 April that had not been adequately explained by politicians.

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He said there had been an over-emphasis of the simplicity of the freedoms that may have given many investors the impression that cashing in their pensions fund attracted a “single, simple, flat-rate benefit”.

However, the withdrawal of money from accumulated pension pots could reduce entitlement to income-related state benefits for many on low incomes.

This would also create disproportionately high effective rates of tax, and could compound issues with the state pension credit system, where pension funding at the very low end was often “unfairly” tax-inefficient, he said.

“Many pensioners will be unaware that the freedom to spend their money as they see fit will in fact have limitations,” Mr Moss said. “The deprivation rule will seek to disregard any money drawn from a pension pot, and spent, transferred or given away in order to secure state benefits, implying a subjective assessment with regards to where the money goes.”

Furthermore, some people approaching retirement may have contracted out of the second state pension in the 1980s but may not realise they will not receive the full uplifted benefit as there will be a contracted-out deduction.

This means many could end up spending their contracted-out money without realising they will need it to top up their state pension.

Mr Moss added: “People need to make informed decisions regarding their savings and how they are effectively managed to secure their long-term economic security – the new pension freedoms are not as simple as some politicians would have you believe.”

Adviser view

Michael Brook, financial planner at Cheshire-based Clarion Wealth Planning, said: “Beyond the 25 per cent tax-free cash entitlement, any withdrawals from pension funds will be classed as income and taxed accordingly, potentially leading members to incur large bills unintentionally and unnecessarily.

“This is particularly the case where large withdrawals are made early in the tax year with emergency tax codes applying. Those who hope to take advantage of the new pension freedoms, however, can still avoid making costly mistakes if they seek specialist advice before proceeding.”