There are a number of disadvantages to withdrawing money from your pension before retirement.
The obvious one is that you will have a smaller pot when you eventually retire.
If at all feasible, it is far better to fund your immediate monetary requirements from other assets like cash savings.
If you are over 55, you may be tempted to withdraw money from your pension, which is likely to be your largest pot of money, even if you have not yet retired, because of rising expenses.
Taking money out of your pension early can be tempting to pay off debts like mortgages that are still owed, cover long-term care costs for family members, pay for school or university expenses for your children, or assist your children in getting on the housing ladder.
There are several reasons, though, why you shouldn’t access your pension until you need it for what it was designed for—your retirement.
Up to 25% of a money purchase or personal pension can be withdrawn tax-free after age 55, but anything taken in excess is subject to tax at your marginal rate.
This may mean that you will be moved into a higher tax bracket if you take on pension income in addition to what you now make.
You could be paying income tax on your pension income at a rate of 40 to 45 percent, whereas if you delay taking your pension until your normal earnings cease, your tax is likely to be lower in future years.
The Money Purchase Annual Allowance (MPAA), which prevents you from contributing more than £10,000 annually to a money purchase pension instead of up to £60,000, is triggered when you withdraw funds from a pension that are not included in the 25% tax-free entitlement.
You will no longer be able to carry forward up to three years’ worth of unused deductions into the current tax year. This will limit what you may invest in a pension during a period when you may be earning the most and capable of investing the most.
The £10,000 limitation includes employer contributions.
That means that your overall pension will be smaller when you retire because you didn’t increase your pension as much as you could have, especially since you also withdrew money from it.
This can result in a less comfortable retirement or the exhaustion of your retirement funds prior to your death.
There are plenty of arrangements that don’t trigger the MPAA. For example:
- You take a tax-free lump sum and buy an annuity that gives you a guaranteed minimum income
- You take a tax-free lump sum from your pension pot and set up a drawdown scheme but don’t yet take any income from the drawdown scheme
- You are able to cash in pension pots with a value of less than £10,000.
Please note: A pension is a long-term investment not normally accessible until age 55 (57 from April 2028 unless the plan has a protected pension age).
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. The interest rates in effect at the time you take your benefits could also have an impact on your pension income.
The tax implications of pension withdrawals should be based on your individual circumstances, tax legislation, and pension regulations, which are subject to change. You should seek advice to understand your options at retirement from Unavida Wealth Management Ltd.
