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Millions could be paying too much tax on pensions

Millions could be paying too much tax on pensions

Millions of people could unwittingly be paying too much tax on their pensions as they struggle to understand lump sum tax rules, an adviser has said.

Under current rules 25 per cent of a pension pot can be withdrawn tax free but research from adviser Money Minder found many savers are not making full use of this rule.

The specialist adviser found merely a third of pre-retirees planned to take the maximum amount of tax-free cash while the remaining two thirds, which equates to 2.5 million people, had no plans to do so.

Money Minder warned this meant HMRC could receive a windfall of several millions of pounds from people who end up paying income tax on money they later withdraw from their pension pot as taxable income.

The research also found that almost half of the 1,000 people aged 55 to 67 surveyed had no idea what to do with their pension savings, while 6 in 10 expect to struggle financially in retirement. 

Ray Black, MD at Money Minder, said: "This is potentially a scandalous situation where people end up giving up some of their hard-earned pensions savings to the taxman because they don’t understand how tax-free cash works. 

"The tax-free cash entitlement allows each individual with pension savings to withdraw up to 25 per cent of the fund value tax-free. It doesn’t have to be taken out all in one go but what many people don’t seem to realise is that if they don’t take it and elect to take income only, for that portion of the fund, the accompanying 25 per cent tax free cash entitlement is lost."

He added: "It appears that some people are putting off taking their maximum tax-free cash because they think they have to withdraw a huge amount of money in one go and won’t know what to do with it. 

"Instead they opt to take their pension as a regular income, not taking the full amount of tax-free cash they are entitled to."

Mr Black pointed to the options available to people who are aware of the tax-free withdrawal rules including full withdrawal or to take it out in instalments. 

The other option was to take a mix of tax-free money and cash that would be classed as taxable income, he said. This would allow pension holders to release tax-free cash in tandem with taking taxable income so as to maximise their monthly income while minimising their tax liability, he said.

But Tom McPhail, pension expert at Hargreaves Lansdown, questioned whether this was a significant problem.

He said: "I’m inclined to think that there is not a major issue. There are so many safeguards in place to warn pension holders about what would happen if they didn’t take their tax-free lump sum.

"It’s in providers' best interest to inform their customers about the tax implications, and there are other safeguards in place, including the mid-life financial MOT and Pension Wise. So I can’t see it being much of a problem."

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