Thinking of unlocking your pension pot early? Even under lockdown, we look at why this should be a last resort and we also look at some of the key drawbacks.It's no secret, that during lockdown, many people have been looking for new ways of accessing income, even including funds that have been theoretically locked away. According to financial broking providers AJ Bell, more than one-in-ten of over 55s with a pension - 11% - have already accessed or are planning to access their retirement pot early due to Covid-19.
While taking a tax-free lump sum from a flexible drawdown pension may be tempting, there can be significant disadvantages and this should only be seen as a last resort.
Most savers will be entitled to take up to 25% tax-free from their pension fund if they are aged 55 or over. However, what many people fail to realise is that you don't have to take the entire 25% in one go - giving you the flexibility to take as much as you need up to the 25% allowance.
Taking a tax-free lump sums involves 'crystallising' some or all of your pension fund to allow a tax-free withdrawal - effectively this involves moving an amount of your pension funds into a separate, 'crystallised' pot and paying out 25% tax-free. For example, for a £100,000 pension pot, you could crystallise the whole amount - the crystallised pension would have a value of £75,000 and £25,000 would be paid to you tax-free. But what if you only needed £10,000? To achieve a £10,000 tax-free lump sum, you would need to crystallise £40,000, leaving you with an un-crystallised fund of £60,000, a crystallised fund of £30,000, and a tax-free lump sum of £10,000. In the future, you could crystallise more of the £60,000 and if the value of that pot grows, your remaining tax-free cash grows too. But beware the tax trap; if you withdraw anything from a crystallised fund, you will immediately trigger the Money Purchase Annual Allowance (MPAA) which will reduce the amount you can normally contribute to your pension from £40,000 per annum to just £4,000 each year, making it much harder for you to rebuild your funds.
Please note, this is written in general terms, it is not advice and you should not act on the above information alone. free2 would suggest that if you have any doubts or questions, you should seek the assistance of a qualified financial advisor before making any decision about your pension, as there are numerous traps for the unwary.
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