Cost of living crisis – beware of hasty pensions decisions, warn tax experts

LITRG’s warning comes after last week’s launch of a government call for evidence on ‘Helping savers understand their pension choices’.¹ In LITRG’s experience, people often do not understand enough about the tax consequences of their decisions.

Pension flexibility² means that many people with ‘money purchase’ or ‘defined contribution’ pension savings can effectively do what they wish with their accumulated pot of money, from age 55.³ Ten years on from the start of auto-enrolment into pensions, ten times more people are saving into defined contribution pension schemes than a decade ago.⁴

While tax relief is usually given on money saved into pensions and investment growth is tax free, tax will likely have to be paid when money is taken out. Some of the knock-on effects can be unexpected and, without careful planning, can leave people with less money than anticipated.

Kelly Sizer, Senior Technical Manager for LITRG, said:

“We urge people not to rush into making decisions about pension withdrawals without fully exploring the tax⁵ and other consequences of their actions, including impacts on welfare benefits.

“We know of people who have received very large tax bills, often unexpectedly, since pension flexibility began. For example, in households where there is a child benefit claim in place, tax charges can include a high income child benefit charge⁶ when a pension withdrawal pushes the person’s adjusted net income over £50,000. This also means the taxpayer must notify HMRC they are liable for the tax and fill in a Self Assessment tax return.

“People should plan ahead where possible. They might pay less tax on money from pensions if it is taken in stages, spread out over a number of tax years, or withdrawn after they have stopped work. For those on lower incomes, tax credits and benefits impacts also need consideration – for example, the taxable element of pensions is also taken into account as income for tax credits.

“Think about the future. If you are looking to take money out of a pension to get you through a spell of financial difficulty, you might wish to pay into a pension again in future if the squeeze on your income eases. However, once you have taken pension benefits under the pension flexibility rules, future tax relief is restricted such that you are limited to paying in £4,000 gross a year⁷, which is a possible tax trap to beware of.

“LITRG’s website guidance⁸ aims to help people understand the potential issues when taking flexible pension withdrawals. And for those aged 50+, free guidance on pension options can be obtained via the government’s Pension Wise service.⁹”

Notes for editors

1. Department for Work and Pensions publication, 14 June 2022. See https://www.gov.uk/government/consultations/helping-savers-understand-their-pension-choices.
    
2. Pension flexibility (sometimes referred to as pension freedoms) was introduced in April 2015. LITRG’s website guidance gives further detail on the tax consequences of withdrawals: https://www.litrg.org.uk/tax-guides/pensioners/what-tax-position-when-i-take-money-my-pension-flexibly.
    
3. The normal minimum pension age for making withdrawals from pensions is currently 55. It will increase to 57 from April 2028. Most people cannot take money out of pensions under age 55 without incurring a tax charge of up to 55% of the amount withdrawn. People should be extremely wary of any companies or schemes that appear to offer earlier access to pensions. Further guidance on pension scams is available from the Financial Conduct Authority: https://www.fca.org.uk/scamsmart/how-avoid-pension-scams.
    
4. The House of Commons library notes that auto-enrolment ‘has reversed the decline in workplace pension saving. The rollout of automatic enrolment from 2012 onwards has led to a tenfold increase in total membership of defined contribution (DC) occupational schemes, from 2.1 million in 2011 to 21 million in 2019. Actively contributing membership rose from a low point of 0.9 million active members in 2011 to 10.6 million members in 2019.’ See https://commonslibrary.parliament.uk/research-briefings/sn06417/.
    
5. You are allowed to take some money (usually 25%) out of your pension tax free, but the rest (usually 75%) is taxable as income. Taxable amounts will be added to other income, probably resulting in an extra tax bill.
    
6. The High Income Child Benefit Charge (HICBC) is a tax charge designed to claw back child benefit where either a taxpayer or their partner has adjusted net income in excess of £50,000. Child benefit is effectively withdrawn at a rate of 1% for each £100 earned by the higher-income partner over £50,000 a year. Therefore, the benefit is fully withdrawn where income of the higher-income partner reaches £60,000 a year. These figures apply for each tax year – so you have to look at your income for the year starting in 6 April one year through to 5 April the next year. The taxable element of any pension withdrawals can therefore – perhaps unexpectedly – create or increase a HICBC.
    
7. This is due to the ‘money purchase annual allowance’ – see https://www.litrg.org.uk/tax-guides/pensioners/what-tax-position-when-i-take-money-my-pension-flexibly#toc-can-i-pay-into-pensions-again-after-taking-money-out- for further information.
    
8. See https://www.litrg.org.uk/tax-guides/pensioners/what-tax-position-when-i-take-money-my-pension-flexibly.
    
9. The government’s Pension Wise service (https://www.moneyhelper.org.uk/en/pensions-and-retirement/pension-wise/) offers appointments to those 50 and over to discuss their pension options. Note that this service provides guidance, not full advice. The LITRG website also explains how to get professional tax advice where required: https://www.litrg.org.uk/getting-help/who-else-can-help-me-my-tax-or-benefits.
    
10. The LITRG is an initiative of the Chartered Institute of Taxation (CIOT) to give a voice to the unrepresented. Since 1998, LITRG has been working to improve the policy and processes of the tax, tax credits and associated welfare systems for the benefit of those on low incomes.
    
    The CIOT is the leading professional body in the United Kingdom concerned solely with taxation. The CIOT is an educational charity, promoting education and study of the administration and practice of taxation. One of our key aims is to work for a better, more efficient, tax system for all affected by it – taxpayers, their advisers and the authorities. The CIOT’s work covers all aspects of taxation, including direct and indirect taxes and duties. The CIOT’s 19,000 members have the practising title of ‘Chartered Tax Adviser’ and the designatory letters ‘CTA’, to represent the leading tax qualification.

Hamant Verma