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Cashing in entire pension at 55 years can come with a tax penalty

ONE in three retirees will cash in their personal pensions and hand over £3.8 billion in tax over the next five years, the UK government has predicted.

It expects 130,000 people a year out of the eligible 400,000 to take advantage of the new freedom from next April for over-55s to convert non final salary or DC (defined contribution) pensions into cash.

It could mean a higher rate taxpayer with a £50,000 pension pot paying the government an extra £19,000 in tax, or a tax rate of 38 per cent, by taking the pension as upfront cash rather than in a modest annuity income.

Tom McPhail, head of pensions research at Hargreaves Lansdown, said: "Tax could easily wipe out a sizeable chunk of people's pension savings p­otentially taking many people into the higher rate tax band who have never paid tax at that rate before.

"Trusting people to act r­esponsibly with their pension savings is a huge step forward but it is essential to back this with the right guidance and advice."

However, Alistair Byrne a strategist at State Street Global Advisors said: "We remain optimistic that the vast majority of people will use the new pension flexibility wisely.

"In fact, the industry may be surprised by how conservative savers can be in spending the pension savings they've worked hard to accumulate.

"Research in the US shows the majority of DC plan members choose not to make any withdrawals from their pension pot until the age of 70.5 when tax rules require them to do so.

"Additionally, our research in the UK shows that where people have chosen to take a tax-free lump sum from their pension scheme, two in three either save or reinvest it."

Paul Green at over-50s provider Saga said: "We polled 2,400 over-50s and found they wanted to be responsible with their new found pension freedom.

"Just 15 per cent of over 50s still working told us they plan to cash in their full pension pot and we found just 23 people who said they planned to blow it on a Lamborghini and living the high life.

"Over half say they plan to use funds to secure a future income for their retirement."

He added: "It is vital that people are properly advised about the tax implications of withdrawing more than 25 per cent of their pension pot before they do something that they may live to regret."

However, the government has also spelt out how people who want to withdraw their cash in stages, perhaps to avoid moving into the higher tax bracket in any tax year, can do so without having to set up a drawdown plan to take income.

They can opt for an "uncrystallised funds pensions lump sum", first taking the normal 25 per cent tax-free lump sum, but then be limited to a maximum w­ithdrawal of £10,000 in any tax year. A second option will be 'flexi-access drawdown', the new name for income drawdown, where savers can combine drawdown with the ability to access capital at any time, subject to the £10,000 annual limit.

The move follows concern over potential 'recycling' of income, whereby anyone could pay large contributions to their pensions up to the £40,000 annual limit and then encash their pot to get 25 per cent back tax free immediately - potentially repeating the trick every year.

The government analysis found only around 5,000 people a year are accessing pension income without limits under the existing 'flexible drawdown' regime, which required a minimum annual pension income of £20,000 before March 2014, since reduced to only £12,000.

Those with less pension income are limited to roughly 150 per cent of the income they could expect from an annuity.

In other changes, annuities will now be allowed to reduce in-payment, the 10-year limit on guarantees where a member dies in receipt of an annuity has been removed, and restrictions on the definition of a lifetime annuity have been eased.

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