People born in 1970 urged to avoid new tax charge this year

This year, people born in 1970 will be able to start accessing their pension under the pensions freedoms reforms introduced in 2015, but experts are advising those wanting to dip into their pension pot to think carefully first.

Tom Selby, director of public policy at AJ Bell, said taking large withdrawals can also result in paying more income tax than is necessary.

If someone dips into their pension pot, then that money, after they have taken a 25% tax-free lump sum, immediately becomes taxable.

"For example, if someone with no other taxable income chose to take a £20,000 taxable withdrawal in 2024/25, they would pay 0% tax on the first £12,570 and 20% tax on the remaining £7,430, leaving a total income tax bill of £1,486.

It is almost a decade since the ‘pension freedoms’ reforms announced by former chancellor George Osborne in his 2014 Budget took effect in the UK.

The changes meant that savers could choose to withdraw money from their pension at age 55 rather than wait until they had reached state retirement age.

From 2028, the age at which people can access their pension will rise to 57, but people born in 1970 can start accessing their pension this year, as they are turning 55.

Osborne also introduced rules that made it possible to pass on your retirement pot completely tax-free if you died before age 75. Selby said: "Chancellor Rachel Reeves has proposed undoing these reforms by bringing pensions into IHT from April 2027 – a hugely complicated process that will lead to substantial delays in paying money to beneficiaries."

Selby urged anyone over 55 who was thinking of taking money from their pension to ask themselves several questions.

Is now the right time to do it?

You can access your ‘defined contribution’ (DC) retirement pot from age 55, with this minimum access age set to rise to 57 by 2028. When you access your pension for the first time, you can also get up to a quarter of your pot completely tax free (more on this later)

Selby said: “However, just because you can do something doesn’t necessarily mean you should – and there are very good reasons to hold off doing so if you can. Perhaps most importantly, the earlier you start taking an income, the longer that income will need to last – and the less opportunity your fund, including the tax-free cash entitlement, will have to enjoy long-term investment growth.

“To illustrate, let’s take someone with a £200,000 pension pot at age 55. If they decide to access their retirement pot as soon as they can, they could get £50,000 of tax-free cash, with the remaining £150,000 available to deliver a taxable income. If we assume they choose to keep their fund invested through drawdown and enjoy investment growth of 4% per year after charges, they could take an annual income of around £7,600, with their fund exhausted by around their 90^th birthday.

“If, however, they held off accessing their pension until age 65 and enjoyed 4% annual growth during that period and in retirement, they could generate around £74,000 of tax-free cash and enjoy an income of around £13,300 a year until age 90.”

Which retirement income option should I go for?

“Whenever in life you choose to access your pension, to get your tax-free cash you will need to choose an income option for the rest of your fund. “The most popular avenue is ‘drawdown’, whereby your pension remains invested and you take a flexible income to suit your needs. This gives you flexibility over how you take an income but requires you to be comfortable taking investment risk and having responsibility for managing your withdrawals sustainably.

“You can also choose to buy an ‘annuity’, an insurance product which pays a guaranteed income for life. These are generally more suitable for people who don’t want to take any investment risk and prioritise income security. If you go down this road, it’s important to shop around for the right product, because once you buy an annuity you can’t change your mind.

“The other main option is to take ad-hoc lump sums direct from your pension, with a quarter of each lump sum available tax-free. These are sometimes referred to in the jargon as ‘uncrystallised funds pension lump sums’ or UFPLS.

Have a plan for your tax-free cash

“As mentioned earlier, when you access your pension you can take up to a quarter of your pot tax-free. For most people, the maximum tax-free cash they can take over their lifetime is £268,275.

“Before taking your tax-free cash, make sure you have a plan for the money. If, for example, you take your full entitlement out and then just shove it in a bank account, the money will risk being eaten away by inflation over time.

“You can also choose to take your tax-free cash in chunks. For example, someone with a £100,000 pension pot who needs £5,000 of tax-free cash to pay off some credit card debt could choose to just take that amount and put £15,000 of their pot in drawdown. This would leave the remaining £80,000 – including the 25% tax-free cash entitlement attached to it – free to grow over the long-term.”

Planning to keep paying into a pension? Watch out for the ‘money purchase annual allowance’

“One thing you need to be aware of when accessing taxable income flexibly from your pension for the first time is the impact it will have on your annual contribution limit or ‘annual allowance’. Usually, you can contribute up to £60,000 per year into your retirement pot tax-free, but if you flexibly access your pension, for example through drawdown or by taking an ad-hoc lump sum, your annual allowance drops to £10,000. Furthermore, you lose the ability to ‘carry forward’ unused annual allowances from the three prior tax years in the current tax year.

“So, if you are planning to keep contributing to your pension after accessing it, you should think carefully about the impact this annual allowance cut will have and consider alternative options. For example, if you just take your tax-free cash, you won’t trigger the money purchase annual allowance and will retain the full £60,000 allowance.”

Planning to make large withdrawals? Consider the impact of income tax

“If you’re planning to access your pension flexibly using drawdown, you need to think carefully about the sustainability of your retirement income plan. If you take too much too soon, you’ll run the risk of exhausting your pot early and relying on the state pension to fund your retirement.

"Taking large withdrawals can also result in you paying more income tax than is necessary. For example, if someone with no other taxable income chose to take a £20,000 taxable withdrawal in 2024/25, they would pay 0% tax on the first £12,570 and 20% tax on the remaining £7,430, leaving a total income tax bill of £1,486.

“If, however, they took a £10,000 withdrawal in 2024/25 and a subsequent £10,000 withdrawal in 2025/26 and had no other taxable income in both tax years, they would pay no income tax at all as both withdrawals would be below their £12,570 personal allowance.”

Watch out for scammers

“When most people access their pension, they will either be moving into retirement and taking a regular income to fund their lifestyle or taking a chunk of money out for a specific purpose, such as paying off a mortgage. However, you need to be wary of scammers who may offer high risk, unregulated investment ‘opportunities’ which often promise sky high returns over short periods of time. Such offers will often come with exorbitant fees and, in the worst-case scenario, will simply be out-and-out fraud, with a criminal taking your hard-earned retirement pot and scarpering. What’s more, by withdrawing a large amount from your pension, you will have taken it from an environment where it can grow tax-free and enjoys the protection of the Financial Services Compensation Scheme (FSCS) protection of up to £85,000 to an unregulated Wild West where you may have little or no protection.

There are a number of simple things you can do to protect yourself from fraudsters:

• Be suspicious of unsolicited calls, texts, emails or unregulated offers on social media: Scams often start with a call, text or email out of the blue offering ‘help with’ or perhaps a ‘review of’ your pensions or investments. Social media is also an increasingly lucrative hunting ground for fraudsters. To be safe, if someone you don’t know contacts you about your pension or investments - or indeed your finances in general - do not engage with them. If you believe someone is trying to scam you, report them to Action Fraud to help protect other investors.

• Be extremely wary of anyone promising large, guaranteed returns or early access to your pension: Another tell-tale sign of a scam is the promise of huge, guaranteed investment returns, often over relatively short spaces of time. These investment ‘offers’ take many weird and wonderful forms, while the rise in popularity of cryptocurrencies has also been an obvious target for financial fraudsters. In addition, anyone claiming they can facilitate early access to your pension is almost certainly a fraudster.

• Only deal with regulated companies and individuals: At the heart of scams are often unregulated ‘introducers’ peddling unregulated investments. While there is nothing wrong with investing in unregulated assets, where fraud occurs these often turn out to be vastly overhyped or entirely fictitious. Even where an unregulated investment is real, if you suffer losses through misselling you will not qualify for FSCS protection.

• Do your due diligence: Scammers’ tactics have become more sophisticated in recent years, with ‘clone’ scams - where fraudsters impersonate a real firm to con you out of your cash - increasingly common. You can cross-check the phone number or email address provided by someone who contacts you with the FCA register to make sure they are who they say they are.

• Don’t be rushed and if in doubt, speak to a regulated financial adviser: High-pressure sales tactics - such as telling someone they need to invest by a set deadline - are a classic scam tactic and should immediately set off alarm bells. Do not be rushed into a decision you aren’t completely happy with. If you want help with your options or are unsure what to do, consider speaking to a regulated financial adviser or visit government-backed retirement guidance service Pension Wise. The FCA’s ‘ScamSmart’ website is another great resource to keep up-to-date on the latest tactics being deployed by fraudsters.”

Check how much state pension you will receive

“Away from your private pension, the retirement income foundation most people’s later years will be built upon will be the state pension. The full new state pension is worth £221.20 per week in 2024/25 and will rise to £230.25 per week from April this year. The current state pension age is 66, with plans in place for increases to age 67 by 2028 and age 68 by 2046.

“You need a 35-year National Insurance (NI) record to qualify for the full state pension. As you approach retirement, it’s worth checking your NI record to make sure you don’t have any gaps that could be filled, either for free by claiming NI credits or by paying voluntary NI contributions.”

Consider ISAs and any other assets, including any defined benefit (DB) entitlements, before making a decision

“When deciding how and when to access your retirement pot, the value of other assets will be a significant consideration for lots of people. If you have a significant defined benefit (DB) pension, for example, you might be comfortable taking larger withdrawals from any DC pensions you have. Equally, those with ISAs or property investments will need to factor those into their retirement income planning.”

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