Cost-of-living: Over-55s risk a tax bombshell on pension pot

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More than half of all pensions accessed for the first time last year were fully withdrawn, often without taking independent financial advice.

There was also a sharp rise in the number of pension withdrawals worth £50,000 or more, analysis from financial advice firm NFU Mutual shows.

Britons are free to make pension withdrawals from age 55, of which 25 per cent can be taken as tax-free cash. Any further withdrawals are added to your total earnings for that year, and are subject to income tax.

Those making large withdrawals could hand a huge chunk of their pension straight to HM Revenue & Customs, making retirement even harder to fund.

In the 2021/22 tax year, more than 700,000 over-55s accessed their pensions for the first time. Of these almost 400,000 – more than half – chose to go fully withdrawn, according to data from the Financial Conduct Authority.

While more than 260,000 were for smaller pots of less than £10,000, the number of pensions over £50,000 that were fully withdrawn jumped 15.5 percent to 17,661.

Worryingly, more than 10,000 of these withdrawals were taken without advice.

NFU Mutual chartered financial planner Sean McCann warned that fully withdrawing a pension can backfire: “Cashing in pension pots of more than £50,000 will push many into the 40 or 45 percent income tax bands and leave them with a large tax bill they weren’t expecting. It will also limit their funds for the future.”

This tax bill can be reduced by phasing withdrawals over a number of years instead of taking it in one go, he added.

Some people cash in their pension funds without a clear idea of what they plan to do with the money, often putting it into a bank account.

By doing this, you will lose pension tax advantages, McCann warned: “You may expose any future growth on the money to income tax, capital gains tax and potentially inheritance tax.”

For those who can afford it, it could make sense to draw pension funds last, as they can be passed on to loved ones free of inheritance tax.

Another danger is once you have made early withdrawals, the amount you and any employer can invest into a pension shrinks to just £4,000 a year, under the money purchase annual allowance (MPAA).

Anyone accessing their pension earlier than planned or taking bigger withdrawals must consider whether this is sustainable, warned Tom Selby, head of retirement policy at AJ Bell: “While in some cases this may be the only option, consider the impact on your finances further down the line.”

Experts suggest a healthy 65-year-old can safely withdraw around 4 percent of their fund each year and be confident it will last throughout retirement, Selby said.

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