Martin Lewis said many people risk paying too much tax or accidentally limiting future savings (Image: Getty)
Martin Lewis has issued a fresh alert to those aged 55 and over regarding costly errors that can occur when drawing money from pension pots for the first time. The consumer champion warned that many people mistakenly believe they can simply withdraw 25% of their pension tax-free without triggering any further tax implications.
Writing in the latest edition of the MoneySavingExpert (MSE.com) newsletter, Martin explained that while 25% of pension withdrawals are typically tax-free, the remainder can still be subject to income tax and could push an individual into a higher tax bracket.
As reported by the Daily Record, he also cautioned that certain pension withdrawals can inadvertently reduce the amount people are permitted to save into their pensions going forward.
Martin wrote: “Withdraw money directly from your pension and only 25% of what you take will be tax free, the rest taxable.”
The financial expert also drew attention to complications arising from emergency tax rules applied by pension providers when someone takes taxable money from their pension for the very first time.
Martin Lewis issued the alert to those aged 55 and over (Image: Getty)
He explained that providers may impose a temporary ‘Month 1’ emergency tax code, which can leave people paying considerably more tax upfront than they actually owe.
Martin said: “Your provider may use an emergency ‘Month 1’ tax code. This can tax the payment as if you’ll get the same amount every month, so a big one off or irregular withdrawal could mean a much bigger tax charge.” While overpaid tax can ordinarily be reclaimed from HM Revenue and Customs (HMRC), Martin recommended making smaller withdrawals or spreading payments throughout the tax year to minimise the risk of overpaying.
The warning relates to defined contribution pensions, sometimes referred to as money purchase pensions, where workers accumulate a pension pot through contributions and investments.
Martin further cautioned that once an individual draws taxable money from their pension, they could trigger the Money Purchase Annual Allowance (MPAA).
Read more: I followed Martin Lewis’ advice and got £4,000 energy bill refund
Read more: Money Saving Expert’s ‘cheat code’ to get free £360 from major bank
This slashes the amount most people can contribute to their pension each year while still receiving tax relief, from £60,000 down to £10,000.
He did, however, clarify that certain exceptions exist.
Withdrawing only the tax-free portion of a pension does not ordinarily trigger the reduced allowance, nor does using pension savings to purchase a standard lifetime annuity.
Martin also noted that people can typically withdraw up to three pension ‘small pots’ worth £10,000 or less without affecting future pension contribution limits.
He encouraged people to seek free guidance before reaching any decisions regarding pension withdrawals.
Those aged over 50 can book a free appointment with Pension Wise, while younger savers are able to access support through MoneyHelper.
Martin added that individuals with more substantial pension pots may also benefit from paying for independent financial advice in order to avoid costly errors.
The full guide on taking your tax-free lump sum from your pension pot is available to read on MSE.com.
