How do cashed out pensions work?
In the pension freedom reforms, you are allowed to make as many withdrawals as you want from your pension pot. For each withdrawal, 25% of the amount will be tax-free and 75% will be taxed like your income. This spares you from paying a huge amount of tax, because you’re not left with just the option to withdraw all your pension at once. But the pension freedom is only applicable to:
- A pension scheme that allows flexible withdrawals, such as ‘defined contribution’ or ‘money purchase’ pension schemes.
- Pensioners who can move their pension to a provider that administers the new freedoms.
It is not applicable to:
- People with ‘final salary’ pensions or ‘defined benefit’ pension scheme.
- Members of public service schemes, such as teachers, civil servants and the NHS, all of which are not allowed to move their pension to providers that support the new freedoms.
Being taxed on your pension
Considering that only 25% of the pension withdrawn is taxable, many people are planning to withdraw their pension flexibly, instead of taking them all out at once as a lump sum. Because then, 75% will be taxable. The problem with this plan, however, is that your pension company will inform HM Revenue & Customs about your flexible withdrawals, and then you will be required to inform all other pension schemes that you are putting new money into within 91 days. Also, your pension provider will be the one to work out your tax deduction, which runs the risk of you overpaying pension tax. To avoid confusions or problems, refer to a tax expert specialising in cashed out pensions.
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