The three reasons to be careful are:
- Accessing your pension now can make it much harder to build your pension pot back up in future if things improve, because your annual limit for tax privileged pension saving could fall by 90%; at present, most people can save £40,000 per year into a pension and enjoy the benefits of pension tax relief; but someone who ‘flexibly’ accesses a DC pension pot worth over £10,000 can trigger the ‘Money Purchase Annual Allowance’ (MPAA) which reduces their annual limit to £4,000; if energy prices fall back and the economy emerges from Recession, those who have dipped in to their pensions now may find that they cannot take advantage of the upturn to rebuild their pensions as quickly as they would wish and may run out of time to undo the damage;
- The first lump sum withdrawal on a pension pot can trigger income tax at an ‘emergency’ rate; if the pension provider does not hold a standard tax code for a saver, under HMRC rules they have to deduct tax at a penal ‘emergency’ rate, as if the saver was going to make multiple withdrawals over the year; although this excess tax can be reclaimed, it means the saver may get less immediate cash from their withdrawal than they hoped; so far HMRC has had to return around £900m in overpaid emergency tax on pension withdrawals since the introduction of pension freedoms in 2015;
- Someone who takes out more than they need for immediate spending and leaves a balance in their bank or savings account could see a deduction in any benefits that they receive; in extreme cases they could be disqualified from benefit altogether; Universal Credit takes account of any savings above £6,000 and applies an absolute cut off at £16,000, disqualifying anyone with savings above this level; similarly, many English local authorities apply a capital limit to their Council Tax reduction schemes with an upper limit of £6,000 being standard. LCP have teamed up with ‘Engage Smarter’ to produce a website where people on benefit can check the potential impact of a withdrawal on their benefit before they take the money out: Will the pension withdrawal reduce your Universal Credit amount? (pensions-and-benefits.uk)
Commenting, Steve Webb, partner at LCP said: “It is entirely understandable that people under severe financial pressure may consider tapping into their pension savings to help pay the bills. But they need to be aware that there are hidden risks in doing so. Those who use ‘pension freedoms’ legislation to take taxable cash in a lump from their pension could trigger a much reduced annual allowance which will make it harder to rebuild their pension in the future. Those on benefit could find that their benefit is reduced or stopped if they leave a lump sum in their bank account. And HMRC will often apply ‘emergency tax’ to withdrawals, leaving savers with less than they expected. Coming on top of the impact on standards of living in retirement, these hidden risks provide additional reasons to regard using pensions to help with short-term spending pressures as an absolute last resort”.
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