Millions of people could be paying too much tax on their pension because they don’t understand the rules properly.
Research by financial advisor Money Minder has revealed that up to 2.5 million pre-retirees were not taking up the option of 25% of their pension pot tax free.
Now they have warned that this decision could mean a multi million pound windfall for the taxman as the group would later be paying tax on any cash they withdrew because it would be taxable income.
The research also revealed that half of those surveyed had no idea what to do with their pension savings and 6 out of 10 expected to struggle financially in their retirement.
Money Minder managing director Ray Black 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.
“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.”
He went on to point out the options available to savers wanting to convert part of their pension:
- The 25% tax free can be taken as a single lump sum or in instalments
- It is possible to take a mix of tax free money and cash allowing people to maximise their monthly income while minimising their tax liability
Tax free lump sum
An HMRC spokesperson responded: “The pension tax rules allow up to 25 per cent of scheme benefits to be paid as a tax free lump sum, but it is down to the rules of the scheme whether or not this is available to members.”