From how much to pay into a pension pot to when and how one accesses the money, there’s a lot to consider when it comes to pensions. During the recent pension-focused episode of The Martin Lewis Money Show, the financial journalist took the opportunity to raise awareness of the tax rules surrounding pensions.
Ahead of the second half of the show, Angellica told viewers they could expect a “major warning” about a pensions “tax trap” – which could potentially cost people thousands of pounds.
A short while later, Martin briefed viewers on the “big issue” of tax when it comes to pensions.
“You can leave your money invested in your pension pot,” he began.
“Then, when you take it out, a quarter of it is tax-free and three quarters is taxed at your marginal rate.
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“In other words, the highest rate of Income Tax you’re paying at that time.”
The financial journalist and campaigner continued: “Now, here’s the issue. If you take your money out of your pension, whether you take it all or you take it in bits, you can’t say, ‘I want the 25 percent tax-free now and I’ll take the rest later.’
“I use a Swiss roll as an analogy. You can have a slice. The jam is tax-free. A quarter of it is tax-free. Three-quarters of it is taxed, and you have to have both.
“Now the problem with that – let’s say you’re taking £20,000 out and you’re a basic rate taxpayer.
“The three quarters of that that’s taxed gets added on top and could push you into the higher rate tax bracket so you’re paying thousands of pounds of tax that you needn’t do.”
Martin went on to explain there is an alternative option.
“You can take your whole 25 percent tax-free lump sum if you put the rest in income drawdown, which is an investment product you can take money out of when you need, or an annuity – which pays you a set income each year for the rest of your life.
“Now the reason this is important is it splits up the jam – the tax-free – from the sponge, that is taxed.
He added: “Let’s say you’re a higher rate taxpayer right now.”
Referring to the first option, he said: “If you were to use this system to take the money out, you’d be paying 40 percent tax on all the taxed amount.
“But later on in your life, you might drop down to a basic rate taxpayer because you’re earning less.
As such, Martin suggested the second option could mean less tax needs to be paid.
He said: “So using this, you’d take the 25 percent now and you wait to take the taxed amount until you’re a lower taxpayer – so it’s more tax efficient.”
Elsewhere during the episode, Martin highlighted that the Pensions Advisory Service offers free help on pensions.
This is an arms-length government agency that can give people advice.
The Martin Lewis Money Show Live airs Thursdays on ITV at 8.30pm.