Why you should think twice before taking money from a pension

If financial pressures have you thinking about dipping into yours, here’s what Aviva's Head of Client Engagement Laura Stewart-Smith says to think about before emptying the pot.

In your late 50s or older? Then you may have considered releasing money from your pension. Many retirees do opt to take a lump sum but doing this could affect your income in years to come.

We get it, pensions can be puzzling and getting your head around them may not be at the top of your priority list. But before you decide whether to dip or not to dip, here are some things to consider:

One of the advantages of saving towards a pension is the tax you save. Pension contributions receive tax relief when you’re saving for retirement, and any growth in the value of your pension savings is also free from tax.

You can usually take up to a quarter (25%) of your pension tax free. If you limit the amount you take to a quarter (25%) or less, you won’t pay any tax on that portion of your pension. You don’t have to take income at this stage, but you will have to pay tax at your marginal rate when you do decide to take some taxable income. Tax rules may change and depend on your individual circumstances. You should talk to your pension provider about the options available.

You can normally withdraw a quarter (25%) of your pension savings tax free, but it’s possible to end up paying more tax than necessary if you take money out without careful planning. This is especially important if you access your pension while you’re working, as any taxable part of your pension will be added to your earnings when calculating the tax due.

It might be tempting to cash in a small pension entirely, even if you don’t need all the money right now. But this could result in you paying income tax on three-quarters of the amount you take.

The tax you pay will depend on your total earnings, plus the amount you take from the pension. This might mean you get taxed at the higher rates, even if you’ve not been a higher rate taxpayer previously.

If a pension is worth more than £10,000, taking more than a quarter (25%) as a lump sum or taking an income will trigger a lower limit on what can be paid into your pensions in the future.

This lower limit is called the Money Purchase Annual Allowance, and it restricts how much benefit you can build up in most pensions without paying a tax charge. This limit is set at £10,000 a year, and covers your contributions and any paid by an employer. The only pensions not covered by this limit are in Defined Benefit schemes – your employer can tell you whether your pension is in a Defined Benefit scheme. Once you've triggered it, this limit could make it difficult to replace pension savings you've decided to take early.

Whether you decide to take your money out of your pension or leave it in there is completely up to you. Just keep in mind that the value of your pension can go down as well as up and you could get back less than has been put in. If you start dipping into your pension now, there's no guarantee it'll last as long as you need it to.

Everyone accessing their pension can take advantage of free guidance available from Money Helper’s Pension Wise service. Pension Wise is government-backed and offers free and impartial guidance about taking pension benefits to anyone aged over 50.