An article by Professional Adviser reveals an interesting statistic, which could be putting some people’s standard of living in retirement at risk. It reveals research by pension provider Just Group, which shows that the number of people withdrawing all of their pension pot at once increased by 16% year on year in 2021/22.
It’s the highest-ever amount of retirement funds that have been fully withdrawn on record. Yet cashing-in a pension at once could result in an unexpected tax charge and may result in someone’s retirement fund running dry sooner than expected.
If your client is considering withdrawing all of their pension pot in one go, read on to discover three important considerations they will need to take into account before doing so.
1. Your client could face a significant tax charge
One of the advantages of a pension pot is that any growth the money makes while in it is not typically subject to Capital Gains Tax (CGT). The tax is charged at either 10% or 20%, depending on your client’s marginal rate.
If your client cashes in their pension pot and puts the money into certain investments or bank accounts, any growth the cash then enjoys could become liable to CGT. This liability could increase further after the chancellor announced in November 2022 that the CGT annual exempt amount will fall from £12,300 to £6,000 in April 2023. It will then drop to £3,000 from April 2024.
Additionally, your client may face an unexpected, and significant, Income Tax charge if they cash in their pension pot. This is because HM Revenue & Customs (HMRC) will usually charge the emergency rate of Income Tax, as it assumes your client will continue to take the same amount every month going forward.
As a result, your client could be pushed into the 40% higher rate or 45% additional rate of tax. While your client can then claim back any overpayment made, they will usually have to wait until the end of the tax year in April to receive it.
According to Money Saving Expert, in Q3 of 2022 alone, almost 10,000 forms to reclaim overpaid pension tax were submitted to HMRC by retirees.
2. Your withdrawal could miss out on future growth potential
Another risk if your client decides to cash in their pension and put the money into a savings account, could be to significantly reduce its future growth potential. This is because pensions are a form of investment that usually include stocks and shares, which typically provide greater growth potential than cash.
As such, keeping the money invested within a pension pot is something your client should consider as it could help inflation-proof their money as the cost of living soars. To demonstrate this, you might want to consider the following.
According to the Office for National Statistics, inflation in the UK reached 10.7 % in November 2022. If your client’s money is not keeping pace with the rate of inflation, it is dropping in value in real terms.
Keeping this in mind, on 8 December 2022, Moneyfacts revealed that the top easy access account offered just 2.6%, and the best five year fixed-rate deal was 4.5%. This is significantly lower than November’s inflation rate, which means your client’s money could be losing value in real terms, something that could reduce their standard of living over the long-term.
Research carried out by Schroders, on the other hand, found that between the start of 1952 and the end of May 2022, UK equities returned 11.7% a year on average. According to the global investment manager, cash returned 6% a year.
As you can see, keeping pensions invested might be a shrewd way for your client to inflation-proof their money. That said, always remember that past performance is no guarantee of future performance.
3. Inheritance Tax
In November’s autumn statement, the chancellor announced that the Inheritance Tax (IHT) threshold freeze would be extended from 2026 to 2028. According to the Telegraph, this could result in the average household’s IHT bill ballooning from £215,000 in 2019/20 to £287,000 in 2027/28.
If your client is facing an IHT liability because of the threshold freeze, withdrawing the total value of their pension could increase their exposure to the tax. As pensions typically fall outside of an estate for IHT purposes, if your client cashes in their pot and places the money into savings accounts or certain investments, it could be liable to IHT.
As the tax is typically charged at 40%, it could significantly reduce the amount your client leaves to loved ones. For this reason, leaving money in a pension pot and gifting it to beneficiaries might be something your client wants to consider as part of their intergenerational wealth strategy.
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If your client cashes in their pension pot and spends it, they may then be at risk of running out of funds later. This may result in them having to significantly reduce their standard of living, or could mean they cannot afford the standard of later-life care they would want.
With all this in mind, a financial planner can confirm whether withdrawing a pension as a lump sum is the best strategy for your client. If you or your client would like to discuss this further, please contact us on hello@ardentuk.com or call 01904 655 330.
As an award-winning financial advice company that was a 2022 VouchedFor Top Rated firm, you can be sure that your clients will receive excellent advice and a high quality service.
Please note
This blog is for general information only and does not constitute advice. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The information is aimed at retail clients only.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The value of your investments (and any income from them) can go down as well as up, which would have an impact on the level of pension benefits available.
Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances. Levels, bases of and reliefs from taxation may change in subsequent Finance Acts.
