Money-saving expert Martin Lewis has issued a stark warning about the potential pitfalls of withdrawing money from pensions.
Speaking on yesterday’s episode of This Morning, Lewis stressed that mishandling pension withdrawals could result in significant financial losses.
“A pension is a tax-efficient saving pot for retirement that employees and their employers can contribute to,” explained Lewis.
“Taking money out of the pension is one of the biggest mistakes you can make if you get it wrong; it can cost you tens of thousands of pounds that you can’t get back.”
To illustrate the complexity of pension withdrawals, Lewis used a jam Swiss roll analogy.
“The jam in my Swiss roll is the tax-free amount, and the sponge is the taxed amount in the savings,” he explained.
“If you just remove it [the jam] from the bank account, what happens is like taking a slice of Swiss roll: you can’t just take the 25 percent [the jam] without also getting some sponge.”
He continued: “If you take £10,000 out, £2,500 is tax-free, and £7,500 is taxable.”
Since the introduction of pension freedom in 2015, individuals aged 55 and older can access their pension pots like a bank account.
While this offers flexibility, Lewis cautioned against withdrawing large sums due to potential tax implications.
“The first 25 percent is tax-free, but the remaining 75 percent is taxed as income,” Lewis noted.
“If you’re still working and in a higher tax bracket, this could lead to substantial tax payments.”
Lewis suggested three alternative strategies for those considering accessing their pension funds.
Taking 25 percent tax-free and buying an annuity provides a guaranteed income for life, taking 25 percent tax-free and drawing down income from the remaining balance, which remains invested, or taking the 25 percent tax-free and leaving the rest invested until retirement, potentially avoiding higher tax rates.
“Let’s say you’re still working and you’re a 20 percent taxpayer,” Lewis explained. “If you’ve taken £10,000 out, £7,500 is going to be taxed at 20 percent.
“Alternatively, you could just take the 25 percent tax-free and leave the rest invested until you stop work and are no longer a taxpayer.
“Then, you’re in a lower tax bracket, and even though it’s taxable, it could be tax-free for you.”
