This pension tax adjustment could make an enormous difference

A suggested tweak to the rules around accessing money from your pension, tax-free, could have really positive ramifications for those looking to make the most out of their retirement. Currently, it is not uncommon for savers to withdraw their entire pension pot in cash. In fact, according to the Financial Conduct Authority data, between October of 2019 and March 2020 nearly 175,000 pots were cashed out in full. That’s 55% of policies and is even more likely to be the action taken by people with pension pots worth under £30,000.

While this is not inherently a bad thing, when you withdraw your pension pot in its entirety you can enjoy 25% of it tax-free. The general approach is to put the remainder into a savings account, however, that results in extremely low levels of interest. Currently, in fact, there is not a single savings account that offers inflation-beating interest rates. A lot of savers will not seek professional advice before making these decisions around their pensions, and so will settle for much lower returns and the potential of zero real term returns.

The suggestion is to adapt those rules to allow the remainder of the pot, after the 25% tax-free withdrawal, to stay invested in the pension. This would make those pension savings last longer and ultimately provide a more flexible standard of living throughout retirement.

While the change would require government action to come into effect, it does echo a similar suggestion that the Financial Conduct Authority has previously made. It is currently possible for some savers to withdraw 25% tax-free and transfer the remainder into a drawdown account. However, this isn’t always the ideal solution. Transferring to a drawdown account isn’t without its potential downsides. For example, it can often carry the risk of being a higher cost environment subject to worse governance and lower returns.

The suggested amendment seems to offer the potential of a win-win situation. In the meantime, if you have any questions or concerns over your own pension savings, retirement planning and the best options available to you, do feel free to reach out.