Pension changes 2015: 45% tax sting for those who cash in pensions

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There's a horrible tax shock which could be lying in wait for anyone who plans to take advantage of new pension freedoms to withdraw cash from their savings: if you want to get your hands on your money it could cost you a jaw-dropping 45% tax.

The revelations have been made by experts at NFU Mutual, who have been analysing guidance documents from the taxman. They say that the instructions tell pension providers to use an emergency tax code unless they receive a P45 or a tax code from the person making the withdrawal.
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Under an emergency code, the higher tax rates will kick in once you withdraw more than £4,500 - at which point you are likely to be charged 40% on the rest of your cash. Those withdrawing £17,834 or more will be charged tax at 45%. It would mean that the bulk of the money is taxed at 40% or 45%.

The problem is that the use of an emergency tax code would lead the system to assume that this was a monthly payment - even if no further payments were planned. As a result, it would multiply it by 12 to work out your expected annual income from the pension payments - and as it would be over the higher tax thresholds it would trigger the higher rate of tax.

Short of cash

Most people would be able to reclaim this excess tax, but they won't be able to do this until the end of the tax year. Sean McCann, a chartered financial planner at NFU Mutual warns: "Some people have never paid such a high rate of income tax in their working lives and may not be able to reclaim their overpayment until at least April 2016."

This could leave them short of money they planned on using at retirement. Those who were intending to use some of the cash to pay off their mortgage or debts will find themselves in limbo until 2016, as the taxman hangs onto the money they desperately need. Those who wanted to start their retirement with a bang will end up starting it with a tortuous wait for their money to be returned instead.

McCann added: "This is unexpected and will alarm people planning to cash in some or all of their pension next year. The new rules may make pensions more flexible and generally more attractive, but there are some pitfalls."

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What can you do?

The good news is that this code will only be used if you cannot provide your tax code or P45. You can either get hold of one of these things yourself - or you can speak to an adviser, who would be able to access these for you. They would also be able to speak to you abut your plans for your pensions saving - and whether taking advantage of the new flexibility in the pension system is the best approach for you.

While nobody likes to pay for advice, anyone planning to retire in the next year or so may do well to factor this cost into their budget. With so many changes and still so many unanswered questions, it may be the best way to ensure you don't end up making a horribly expensive mistake when you retire.

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