The COVID-19 pandemic has caused a lot of economic uncertainty. Many people have lost their typical income sources and are looking for extra help. According to an HMRC report, many have cashed in their pension. But is withdrawing your pension early something you should do?
HMRC reported that 347,000 people withdrew money from their pension between July and September. The figure is a notable increase from last year, and the decision to cash in could be down to the COVID-19 crisis. The option to withdraw early is a new thing, following the Government's pension reforms in 2015.
The option to cash in a part or all of your pension before retirement can provide you with access to income. At a time when you might be out of work or close to losing your job, the idea of cashing in can seem beneficial. But withdrawing early comes with certain drawbacks.
What you should know about early pension withdrawals
The changes to British pensions allow pensioners to withdraw all or part of their pension even if they are still working. The early withdrawal option is available to anyone 55 or over.
But there are tax implications to consider if you choose to withdraw early. Your decision to cash in could:
Push your income tax bracket higher
You can withdraw 25% of your pension tax-free if you are 55 or over. But anything above this is subject to income tax for the year. If you take out a significant sum of money, then you could end up moving into a higher income tax bracket.
Face an emergency tax
You should also be aware that HMRC could apply an emergency tax to your withdrawals. If you are withdrawing a lump sum that’s above the 25% threshold, your pension provider is required to place an emergency tax cover on your payment. The emergency tax could result in you paying a lot more tax.
Influence your future tax reliefs
Taking money out early could have an impact on your future tax reliefs. You can currently pay up to £40,000 or all of your salary into a pension and receive tax relief on those contributions in what is known as your annual allowance.
If you withdraw over 25% of your pension, your tax relief goes down. Your annual allowance turns into a money purchase annual allowance. The allowance is just £4,000, which makes building your pension pot a lot tougher.
Cashing in when you’re under 55
While it’s not illegal to cash in on your pension before you are 55, it can be costly. Many fraudulent companies are currently claiming to help you do this, and you shouldn't listen to their promises. If you withdraw money when you are under 55, you could pay a 55% tax on it on top of any fees the services could charge.
There are two situations when you can withdraw your pension when you are under 55. It is available if:
- You are too ill to work, or you have an illness that means you might not live longer than a year
- You have a protected retirement date specified in your pension plan granted before 6 April 2006
Think carefully before withdrawing your pension early
While cashing in your pension early could provide instant relief to your financial situation, you need to keep in mind the long-term consequences. You could end up paying more income tax in the immediate future and make it harder to re-build your pension pot. A smaller pension pot could mean you don’t have enough money to live on once you retire. This could mean you’ll end up pushing your financial problems into the future.
You should consider your current economic situation but also keep in mind what cashing in means for the future. You don’t want to end up in a situation where you don’t have enough money in your retirement. It’s a good idea to look at different options available to you. Don't make hasty decisions but explore your options and understand the risks associated with withdrawing your pension early.
PensionBee CEO, Romi Savova, commented: “As savers will likely be feeling the pinch due to the current economic uncertainty, accessing their pension early may offer some financial relief.
"However, as life expectancies continue to rise, with ONS data stating that they’re at their highest ever observed level in the UK, savers should ensure that they’ve saved enough to last well into old age.
"Leaving your pension untouched, and your savings invested, for just a few years longer could dramatically increase your income in retirement. When a saver does eventually retire, they should try to adopt a sustainable withdrawal strategy of no more than 4% of the pension value annually."