Don’t get stung with a surprise tax bill for your pension

It’s a failing of the financial services industry that, despite all the recent talk of pension freedoms, a quarter of UK over-55s may not fully understand the tax treatment of their pension income.

It’s time to put that right. Recent research* by YouGov and Old Mutual Wealth reveals that almost one in ten people (9%) who now have access to their entire pension savings don’t know that pension income is taxable. With 18.5 million people aged 55 and over in the UK, that’s 1.7 million people who could face a surprise tax bill now they have more flexible access to their savings.

A significant one in four people (24%) don’t fully understand that, normally, 25% can be taken tax free with the remaining amount taxed at their marginal tax rate.

This could prove disastrous if people don’t take advice to understand their options better. The new flexibilities are great but poor planning could lead to surprise tax bills and it’s vital that people understand the tax implications.

Understanding income options

The research also reveals that only one in four (26%) people who have immediate access to their pension savings have a good understanding of income drawdown. This means that almost 13.5m people do not understand the main method of withdrawing cash without buying an annuity. 

However, this is an improvement from the 17%* of people who said they had a good understanding of pension drawdown when asked in July 2014, showing that awareness is at least improving.

On annuities themselves, just 38% of people suggested they had a good level of understanding of them. 

What are people thinking of doing with their pensions?

Research before the new freedoms began on 6 April showed that over half (56%) of those eligible were planning to access their pension savings in some format, including:

  • 14% wanting to take 25% tax free cash and leave the rest invested
  • 11% taking different amounts as and when they like
  • 10% taking regular drawdown payments 
  • 8% planning to take some of the money from their fund, leaving the rest invested
  • 6% wanting to take their whole pension as cash despite tax implications 
  • 7% saying they would withdraw their entire pension fund of less than £30k under small pots rules.

Only 14% of people planned to purchase some form of annuity. You can find more details on your retirement options through lots of articles and case studies here.

The best way forward - expert advice

Having greater control over how and when you take income from your pension savings is a positive change which will help you to plan the retirement you really want. But the stats above show that not everyone has a full understanding of the consequences of each option, so make sure you are not one of them.

The Government’s Pension Wise service is a good place to start for guidance. They will give you a free consultation to help you understand your options: over the phone, online or face-to-face at a Citizens Advice Bureau.

But, only by seeking full professional advice will you get personalised recommendations tailored to your individual circumstances.

* Source: Old Mutual Wealth Retirement Income Uncovered report – Dec 2014

All figures, unless otherwise stated, are from YouGov Plc. Total sample size was 1023 adults aged 55 and over. Fieldwork was undertaken between 11/03/2015 - 17/03/2015.