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Write to Kate with your pension problem: pensionsdoctor@Finance.co.uk. Columns are published twice a month on Tuesday mornings
Dear Kate,
I’m short of money, but still some way off retirement, and considering accessing my pension now. What are the consequences? I am 53.
AW, Kent
The financial impact of coronavirus is being felt by millions of people across Britain and some people may be tempted to withdraw money from their pension and other savings to tide them over. Before taking this step it’s vital to understand your options and the consequences of accessing your pension early.
You can access your cash savings at any time, but you normally need to be age 55 or over to access your defined contribution (DC) pension. The only exceptions to this are if you are in ill-health, or have a "protected" pension age of lower than age 55.
If you do access a pension before 55 you are likely to be hit with a 55pc tax charge. For this reason, it is highly unlikely a reputable provider would ever recommend this course of action.
If you are 55 or older you should may be able to access your DC pension flexibly and take as little or as much as you would like. Whether you can depends on your scheme – modern plans generally allow far greater flexibility.
But just because you can access a pension before you stop work, doesn’t necessarily mean you should. Taking any money from your pension can have longer term consequences. If you have other sources of money, such as cash savings or ISAs, these might be better to use ahead of pensions.
Falling stock markets
Pensions are likely to be partly invested in stocks and share, which in March experienced a sudden fall in value. Taking money out of your pension, when its value has fallen, means the money you withdraw doesn’t have the chance to recover its value if stock markets bounce back, potentially reducing future retirement income.
Ask Kate a question | The Telegraph’s pensions doctor
You can pay up to 45pc tax on your pension income
You can take up to 25pc of your pension as a tax-free lump sum. The rest is taxed as income when it’s withdrawn at your highest "marginal" rate of income tax at that time. This could mean you pay 20pc, 40pc or even 45pc tax on your pension income if you are a UK tax payer. There are different income tax rates for Scottish taxpayers.
If you take out a large amount from your pension, or even cash in the whole pension pot in one tax year, this could push you into a higher tax bracket. Doing this would mean you would pay more tax than you needed to, and receive a lower net income, than if you had spread smaller pension payments over more tax years, leaving you worse off.
Once you take cash out, there’s a limit on what you can put back in
Accessing your DC pension flexibly, such as taking a taxable income or lump sum from your pension over and above the tax-free amount, limits the amount you and your employer can pay into a DC pension in the future without incurring a tax charge.
Before you access your DC pension, you and your employer can normally pay up to a total of £40,000 a year into a pension without incurring any tax charges. This is known as the pension annual allowance.
Once you flexibly access your pension, the annual allowance into DC pensions is cut to £4,000 a year. This could severely affect your ability to rebuild your pension and get your retirement savings back on track post the coronavirus crisis.
As always, if you want more information I recommend Pension Wise, a free government-backed guidance service where you can book a telephone appointment. Note that, unlike a financial adviser, Pension Wise cannot tell you what to do with your pension.
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