Martin Lewis has explained the tax rules and complications that can arise when drawing on your retirement savings
Martin Lewis has issued a warning to those aged 55 and above about expensive mistakes that can happen when withdrawing money from pension pots for the first time. The consumer champion cautioned that many people wrongly assume they can simply take out 25 per cent of their pension tax-free without triggering any additional tax consequences.
Writing in the latest edition of the MoneySavingExpert (MSE.com) newsletter, Martin clarified that while 25 per cent of pension withdrawals are generally tax-free, the remaining amount can still be liable for income tax and could push someone into a higher tax band.
As reported by the Daily Record, he also warned that certain pension withdrawals can unintentionally reduce the sum people are allowed to save into their pensions in future. Martin wrote: “Withdraw money directly from your pension and only 25 per cent of what you take will be tax free, the rest taxable.”
The financial expert also highlighted complications stemming from emergency tax regulations applied by pension providers when someone takes taxable money from their pension for the very first time. He explained that providers may apply a temporary ‘Month 1’ emergency tax code, which can result in people paying substantially more tax initially than they actually owe.
Martin explained: “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 usually be reclaimed from HM Revenue and Customs (HMRC), Martin advised making smaller withdrawals or spreading payments across the tax year to reduce the risk of overpaying. The alert concerns defined contribution pensions, sometimes known as money purchase pensions, where workers build up a pension pot through contributions and investments.
Martin also warned that once someone draws taxable money from their pension, they could activate the Money Purchase Annual Allowance (MPAA). This reduces the amount most people can contribute to their pension annually while still receiving tax relief, from £60,000 down to £10,000.
However, he clarified that certain exceptions apply. Withdrawing only the tax-free element of a pension does not normally trigger the reduced allowance, nor does using pension savings to buy a standard lifetime annuity.
Martin also pointed out that people can generally withdraw up to three pension ‘small pots’ worth £10,000 or less without impacting future pension contribution limits.
He urged people to obtain free guidance before making any decisions about pension withdrawals. People aged over 50 can arrange a complimentary appointment with Pension Wise, while younger savers have access to guidance through MoneyHelper.
Martin also pointed out that those with larger pension pots could benefit from seeking paid independent financial advice to steer clear of expensive mistakes. The complete guide on withdrawing your tax-free lump sum from your pension pot can be found on MSE.com.
