One in five retiring this year could be at risk of unnecessary tax bills

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Nearly one in five people (19%) planning to retire this year with pensions could be risking unexpected tax bills, by withdrawing more than the tax-free lump sum that savers can take from their pensions at retirement, according to new research from Prudential.

Under the pension freedoms reforms, most pension savers over the age of 55 are entitled to take some or all of their pension savings in the form of a cash lump sum, with the first 25 per cent being tax-free.

However, in its Class of 2017 study, Prudential found that 19 per cent of those retiring this year with pensions are planning to withdraw more than the 25 per cent tax-free limit from their pension. This could leave them with a one-off tax bill or having to pay tax at a higher rate than they normally do.

Prudential’s unique research into the financial plans and aspirations of people planning to retire in the year ahead – now in its tenth year – found that more than two in every five people planning to retire in 2017 (44 per cent) are planning to withdraw some cash from their pension savings. A quarter of retirees will stay within the 25 per cent tax-free lump sum limit.

The research shows that the most popular use of the cash is holidays, with one in three (34 per cent) of those taking cash from their pension fund planning to spend it on trips away, while 24 per cent will use at least part of the money to pay for home improvements and decoration and 13 per cent will buy a new car.

However, new retirees are not only planning to spend the money on themselves – their families will also benefit, with nearly one in five (18 per cent) saying they’ll gift cash to their children and grandchildren. Many are also planning to pay-off debts, with 18 per cent using some or all of the cash to pay off mortgages while 14 per cent will use it to clear credit card debts or loans.

Financial Conduct Authority data shows that fewer than half (47 per cent) of those who withdrew all the money from their pension savings between July and September 2016 sought professional financial advice before doing so. However, the proportion seeking advice had increased from just 29 per cent at the start of 2016. Meanwhile, Treasury data released as part of the Spring Budget shows that the amount of cash being taken from pension funds is higher than expected when the freedoms were first announced. It was initially estimated that the changes would mean a total of £900 million of extra tax being paid in the tax years 2015-16 and 2016-17. In fact, a total of £2.6 billion in extra tax is now expected to be paid in the two years to April 6, 2017.

Stan Russell, retirement income expert at Prudential, said: “Being able to withdraw lump sums from their pension pots gives savers unparalleled flexibility on how to spend their money, and it is clear that people retiring this year are making full use of this benefit. Many of the Class of 2017 are withdrawing money to sort out their finances for retirement, with many paying off mortgages and debts, as well as helping out family and enjoying themselves.

“However, it is also clear that without careful planning, the tax man could benefit from people making the most of the newly acquired access to their pension funds.

“For many people approaching retirement and considering how to make the most of their savings, a consultation with a professional financial adviser where appropriate, or seeking guidance from the numerous free resources available including The Pensions Advisory Service could help to ensure they access their pension in a way that benefits their long and short-term aims. And of course for those who are still in work, saving as much as possible from as early as possible in their career is the best way to help secure a comfortable retirement.”