Don't get caught in these pension tax traps

If you're thinking of using your pension like a 'bank account' come April next year, be warned you could be hit by harsh taxes, penalties and lose valuable retirement perks.

Chancellor George Osborne has said no-one has to buy an annuity ever again and introduced a new type of drawdown that allows you to effectively use your pension as a bank account. But if you're dipping into your pot beware of these pitfalls.

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Unexpected taxes

Everyone knows about the 25% tax-free lump sum that can be taken from a pension with charge but if you're planning on taking a larger chunk of your money out then you'll pay income tax at your 'marginal rate' – this is a way of saying it's taxed like earnings and mean you could pay 40% or even 45% on the money you strip out.

If you think the new freedoms are a good way to get your money out of your pension and into the bank, be aware that money sitting in savings makes up part of your estate for inheritance tax (IHT) purposes so your loved ones could lose 40% of it, whereas a pension will ring-fence your money and allow it to be passed to your loved ones without incurring IHT.

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Sneaky charges
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Pensions were not built with an end goal of taking the entire pot in cash, the pot was supposed to be used to buy an annuity. As such many pensions will charge hefty exit fees – up to 20% of the money saved – should you want to access your money.

It's not just the pension providers that will charge you either, the taxman will too if you fail to track down all your pension pots. Retirees will have to pay a £300 penalty if they take money from their pot and then fail to inform all their other pension schemes within 31 days to tell. The fine increases by £60 a day up to a maximum of £3,000.

Don't miss out

Pensioners should also check the small print of their pension contracts to make sure they don't miss out on any perks by taking their pot as cash. Guaranteed annuity rates are a typical perk of older pensions and offer a very generous annuity rate, sometimes as much as 10%, as long as the retiree buys their annuity. These are now very costly for insurers, as annuity rates are around half that amount these days, so don't expect them to tell you about it!

Read more:

Aspirational retirees have been sold a lie over pension perks

How to benefit from a new pension tax break

Tax-free lump sum: what new freedoms mean