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Money expert Martin Lewis has issued a “tax warning” to pension savers, giving advice that could help hold on to tens of thousands of pounds.
Most personal pensions will set an age when you can start withdrawing money, which is usually not earlier than 55. But how and when you take the money is important, and could cost savers dearly if they “get it wrong,” says Mr Lewis.
Up to 25 per cent of personal pension money can usually be withdrawn as a tax-free lump sump, with the rest subject to tax based on your income tax band. However, there could be major tax savings to be made if you plan to drop a tax band in later life.
Mr Lewis explains that you can take your 25 per cent tax-free lump sum and put the rest in income drawdown, an investment product that you can take money out of when you need to. Or you could opt for an annuity, which pays you a set income each year for the rest of your life.
With either option, it would mean that the remainder of your pension pot (which isn’t tax-free) would be taxed at the point you access the money, which may be after you have moved down a tax band.
Speaking on a special pension-themed episode ITV’s The Martin Lewis Money Show, the personal finance expert said: “So why is this important? Imagine that right now you’re a higher 40 per cent rate taxpayer, and at a later date, once you retire, you’re not going to have as much income. You’d be a 20 per cent rate taxpayer.
“So you take £10,000 out right now, £7,500 of it is taxed at 40 per cent – but if you could wait for it, it’d be taxed at 20 per cent, so less tax would be paid. This could be £1,000s or £10,000s difference that you’re unnecessarily paying. So please get guidance on that.”
The money expert advises that anyone considering the move gets free one-on-one advice from Money Helper (if under 50) or Pension Wise (if over 50). Both are government-backed services.
Here are more top pension tips backed by the money saving expert:
1. Pensions are saved from pre-tax income
Money you put into a personal pension will effectively maintain 100 per cent of its value, advises Mr Lewis, meaning it is not taxed in the way other savings and investments can be.
This is because of tax relief, where the government automatically gives back tax you would have paid as an additional deposit into your pension pot.
So for someone on the basic income tax rate of 20 per cent, an £80 deposit will be boosted to £100. Those on higher rates can also claim additional relief to reclaim the right amount of tax back.
2. You could have hidden money in lost pensions
If you’ve lost touch with a pension provider, it’s possible they won’t know how to pay you when you retire. This could mean tens of thousands of pounds which have been hard-saved going to waste.
There are a number of steps that can be taken to ensure no pension pot is lost, with the government launching a tool in 2016 to help find old pensions.
Mr Lewis said: “Nearly three million pensions are thought to be ‘lost’, often these are worth £10,000 – this is not trivial money. So, try contacting your ex-employer if you know who they are and digging out your paperwork if you can.
“If not there are a number of pension tracing services, an easy one is the Pension Tracing Service tool on gov.uk, it can list over 200,000 pension schemes.”
3. A rule of thumb for putting money away
It can be difficult to decide how much money to put into a pension. Mr Lewis gives his rule of thumb: “Take the age you start a pension and halve it. Then aim to put this per cent of your pre-tax salary into your pension each year until you retire.”
He acknowledges that this might be tricky for some, but writes that “the real takeaway is start as early as possible with whatever you can, as you’ve longer for the gains to compound.”
4. How to get a ‘hidden pay rise’
By law, all employers must auto-enrol their employees into their pension scheme and contribute on their behalf. Since 2019, the minimum contribution rate has been eight per cent, with employers required to pay in at least 3 per cent.
This means it often falls to the employee to pay the other 5 per cent. This can seem like a sizeable chunk of your income, but Mr Lewis advises against opting out. If you are not enrolled in your workplace’s pension scheme, you will also miss out on the their contributions to your pot.
5. Don’t accidentally leave your pension to your ex
Pension savings can’t be left in your will. Instead, you need to fill out an ‘expression of wish’ form to tell your pension provider who should receive your savings if you die.
Mr Lewis advises that you should always fill one in, but don’t forget about it once you do. After a divorce or break up, it’s wise to change your expression of wish to ensure you’re not leaving your pension to an ex-partner.
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