There has been a big increase in the number of people dipping into their pensions amid the cost of living crisis, with more expected to take this route to pay for spiralling bills.
Latest data from HMRC shows that in the financial year 2022 to 2023, £12.9 billion in taxable payments was withdrawn from pensions flexibly, compared to £11.2 billion in 2021-2022 and £9.3 billion in 2020-2021.
Between 1 April and 30 June 2023 alone, £7.56 billion of taxable payments were withdrawn from pensions flexibly by 567,000 individuals, and the average taxable withdrawal was £7,143, up from £7,067 in the same period a year earlier. This represents a 17% increase in the number of withdrawals since 2022 and a 67% increase since the same period in 2020.
Alice Guy, head of pensions and savings at interactive investors said: “It’s extremely worrying that so many more people are withdrawing funds from their pensions, and at higher rates. Pension savings take years of dedication and hard work to build and it’s a huge concern that so many are having to dip into these savings, at potentially unsustainable rates.
“The raising of the State Pension age means people often have a gap between winding down in the workplace, perhaps going part time, and receiving the State Pension. We sadly see that many people in their mid-sixties are struggling to make ends meet before they receive the State Pension. This means that many older workers are facing a huge dilemma, often needing to focus on immediate needs over long term financial goals.”
Worryingly, thousands of pension withdrawals were performed without people seeking financial advice. Those thinking about withdrawing from their pension pots need to be aware of the significant financial risks they face doing so.
Stephen Lowe, group communications director at Just Group said: “The underlying worry is that people may be taking more out of their pension to tide them through the cost-of-living crisis but are unaware of the long-term consequences. They may have plans to increase their savings in the future to make up for what they’ve withdrawn, but by triggering the MPAA they significantly limit the tax relief future pension savings will attract – making that saving much harder work.
“We really don’t know how many people understand the longer-term consequences of taking their first flexible payment. So, there’s one simple piece of advice for everybody considering dipping into their pension pot – either seek professional, regulated advice or take advantage of the free, independent and impartial pensions guidance from government-backed Pension Wise.”
What are the downsides of withdrawing my pension early?
If you’re planning to take money out of your pension earlier than you’d planned to cover rising living costs, or for any other reason, make sure you’re fully aware of the potential financial consequences of doing so.
You could be hit with higher tax bills
Those aged 55 or over can withdraw 25% of their pension pot free of tax – but for any withdrawals over this amount, pension withdrawals are considered part of your income and taxed accordingly.
Not only does this mean the value of your withdrawal will be cut down by the taxman, but combined with your current income, it could even push you into a higher bracket and subject you to a higher rate of income tax altogether.
For example, John is 60 years old and earns £35,000 a year. He decides to take £50,000 out of his pension which is valued at £100,000. This is how much tax he’d have to pay:
|Pension: taxable part||£37,500|
|Take off: personal allowance||-£12,750|
|Taxable amount, after allowances||£59,930|
Then, applying tax:
|First £37,700 @ 20% (basic rate)||£7,540|
|Remaining £22,230 @ 40% (higher rate)||£8,892|
|Total tax bill||£16,432|
If John hadn’t cashed in his pension, he would have paid only £4,486 in income tax for the year. So, the extra tax he’ll have to pay as a result of his pension withdrawal amounts to £11,946.
Bear in mind that if your income exceeds £100,000 you will also start to lose your £12,570 tax-free allowance for that year – it goes down by £1 for every £2 you earn over the £100,000 threshold, and at £125,000 or more it disappears completely.
Make sure you have done the maths and have fully considered the tax implications of any pension withdrawals you may be considering. If you are 55 or over and are thinking about taking a tax-free lump from your pension, read our article Should I take my tax-free pension cash at 55? for more information.
You could lose your Annual Allowance
If you take more than your tax-free lump sum from your pension, then you will see your Annual Allowance – the amount you can contribute to your pension each year and still benefit from tax relief – drop from £60,000 to £10,000, known as the Money Purchase Annual Allowance (MPAA).
This could be a roadblock to anyone planning to take some of their pension now and rebuild their retirement savings later on once they are more financially stable, as it enormously reduces the rate at which you can grow your pension. Wealth management firm Quilter is calling on the Chancellor to relax these Annual Allowance rules for the current tax year, so that people can withdraw more of their pension without endangering their financial future.
Your could end up leaving your loved ones a bigger inheritance tax bill
Any money that is left in your pension when you die is normally free of inheritance tax, so if you can afford to, it may be a good idea to make it the last thing you spend. As a general rule, other savings and investments are subject to inheritance tax but pensions aren’t.
That means if you have a defined contribution pension and you die before you reach the age of 75, you can usually pass your pension tax-free to a nominated beneficiary. If you have not started taking money from your pension this can be taken as a lump sum payment.
If you were taking an income from your pension using flexible drawdown or flexi-access drawdown at the time, your dependants can still receive a tax-free income from the remainder of your pension. If you die when you’re over the age of 75, your pension pot will still transfer tax-free, but your dependants will have to pay income tax at their marginal rate of income tax, on any income they receive from it, in the same way as you would have.
Find out more in our guide What happens to my pension when I die?
You’ll have less to live on in retirement
The most obvious risk involved with taking money out of your pension early is simply that you will have less to live on during your retirement. Not only can it be really hard to rebuild a depleted pension thanks to the MPAA, but having less money in your pot means that you lose out on the benefits of compound interest.
Compound interest is when income is reinvested to generate more income, and gains grow on gains.
Rather than dipping into your retirement savings, you might want to look at ways you can cut costs and boost your income. Our article on 21 ways to save money has lots of suggestions that may help you reduce your outgoings, while you should also ensure you are claiming any benefits you are entitled to. Read more about the logistics and risks of taking some of your pension early in our article Should I use my pension to boost my income?
Where to seek financial advice
It’s undoubtedly an extremely difficult time for many, and no-one should feel ashamed for considering withdrawing some of their pension to cover rising bills. However, it is extremely important to seek financial advice and learn about the risks involved before taking any of your pension early.
If you’re considering getting professional financial advice, Aviva is offering Rest Less members a free initial consultation with an expert to chat about your financial situation and goals. There’s no obligation, but if they feel you’d benefit from paid financial advice, they’ll go over how that works and the charges involved.
We also have a dedicated section for articles to help people with the rising cost of living, with guides on everything from keeping bills down and government benefits to boosting your income looking after your mental health.
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