Pensions: Expert offers tips for contributions
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Rising inflation and soaring energy and food bills are difficult for millions of people to cope with. As a result, individuals may be turning to their savings for an extra boost, and a pension might be their first port of call.
Pension experts have warned there are three “hidden risks” individuals need to be aware of before accessing their pension – aside from the impact on living standards.
Firstly, accessing one’s pension now could make it much harder to build up savings in the future if circumstances improve.
This relates to the Money Purchase Annual Allowance (MPAA), which means if a person decides to take money from their pension, the amount they can contribute while still getting tax relief could drop.
The difference could be substantial, as if the MPAA is triggered, it limits tax relief savings to £4,000 a year, rather than £40,000 annually – a 90 percent drop.
If circumstances were to improve – for example, if energy prices were to drop again, and Britain backed away from a recession, individuals would not be able to take as much advantage of their pension than they otherwise would have been able to.
Another so-called “hidden risk” also relates directly to the pension pot, as a withdrawal could trigger income tax at what is known as an emergency rate.
If a person withdraws for the first time, and their pension provider does not hold a standard tax code for a saver, problems could ensue.
Under HMRC rules, the provider would have to deduct tax at an “emergency rate” which can often be hefty as it presumes the savers was going to make multiple withdrawals over the year.
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The tax can be reclaimed eventually to restore equilibrium, but it would affect the cash the saver gets immediately.
The final hidden risk of accessing one’s pension savings relates to those who are claiming benefits.
Benefits can be claimed for a wide number of reasons and provide important support to millions right across the country.
However, taking out more than one needs for immediate spending from a pension could impact eligibility for benefits.
If a person leaves a balance in their bank or savings account, they could see a deduction in the benefits they receive.
In some more extreme cases, they could find themselves barred from receiving the benefit altogether.
For example, Universal Credit takes account of savings above £6,000, applying a cut off at £16,000 – meaning anyone who has above this level is disqualified.
As the same may apply to support such as council tax reduction, it is vital to think carefully about pension access and whether it is the best decision in the long run.
Sir Steve Webb, partner at LCP, said: “It is entirely understandable that people under severe financial pressure may consider tapping into their pension savings to help pay the bills.
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“But they need to be aware that there are hidden risks in doing so.
“Those who use ‘pension freedoms’ legislation to take taxable cash in a lump from their pension could trigger a much reduced annual allowance which will make it harder to rebuild their pension in the future.
“Those on benefit could find that their benefit is reduced or stopped if they leave a lump sum in their bank account.
“And HMRC will often apply ‘emergency tax’ to withdrawals, leaving savers with less than they expected.
“Coming on top of the impact on standards of living in retirement, these hidden risks provide additional reasons to regard using pensions to help with short-term spending pressures as an absolute last resort.”
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