Will you get taxed on your cashed out pension?
A pension fund is money saved up for your retirement. But under rules introduced in April 2015, you now have an option to take out your pension before you reach the normal retirement age of 65. This is both good news and bad news.
Good, because you now have a possible source of funds. Bad, because you might not have enough money to live the good life when you retire. Cashed out pensions from the age of 55, for example, will reduce the amount you will enjoy upon retirement, so it’s important to understand all the ins and outs of cashing out your pension before you do so, especially when it comes to tax on your pension!
What is the negative impact of early cashed out pensions?
Expensive tax payment
If you take out your whole pension fund as a cash lump sum, 75% of it will be considered taxable income. How much tax you have to pay will be based on your highest tax rate. That is, your 75% cashed out pension will be added to the rest of your income, the total of which will form the basis of your tax rate. It could be the biggest tax payment you’ll ever make.
Reduced entitlement to benefits
Say you only take out a large percentage of your pension pot, leaving a small amount behind. This will decrease the number of benefits you will enjoy now, or as you grow older. A small pension will not be enough to pay for long-term care needs. But you really need the money to clear debts. There are better alternatives available. You just need to look for them.
Reduced tax relief on pension savings
Obviously, you won’t enjoy tax relief with early cashed out pensions, since you have to pay taxes on 75% of it. If you take out your pension as flexi-access drawdown, withdrawing only a partial amount, you will also trigger the Money Purchase Annual Allowance (MPAA), which will determine how much tax relief you can enjoy. For example, if you cash out £10,000 from your pension pot, the tax relief you’re supposed to get from the MPAA is reduced from £40,000
to £10,000. Simply put, your non-taxable pension will only be £10,000 rather than Â£40,000. Anything over that amount will become taxable income.
More tax charges after your death
Whatever money is left in your pension pot will become part of your estate when you die, which is designed for Inheritance Tax purposes. Instead of your pension going to surviving family members after your death, it will now be taxable.
When Cashed Out Pensions Don’t Apply
Before you sign up for any pension fund scheme, make sure it offers cash withdrawal, if you intend to do so in the near future. Not all pension providers and schemes allow for cashed out pensions, so be sure to shop around.
Cashing in your pension is also not applicable if you receive pension from a former spouse or civil partner, as a result of a divorce. The same thing is true if your pension have certain protected rights.
If you think you may be owed a tax refund from cashing out your pension speak to one of the team today at firstname.lastname@example.org