The money saving expert said many people risk paying too much tax or accidentally limiting future pension savings when withdrawing retirement cash.
Martin Lewis said many people risk paying too much tax or accidentally limiting future pension savings when withdrawing retirement cash.(Image: PA)
Martin Lewis has issued a new warning to people aged 55 and over about costly mistakes that can happen when taking money out of pension pots for the first time. The consumer champion said many people wrongly assume they can simply withdraw 25 per cent of their pension tax free without triggering other tax consequences.
Writing in the latest edition of the MoneySavingExpert (MSE.com) newsletter, Martin explained that while 25 per cent of pension withdrawals are usually tax free, the remaining amount can still be taxed as income and could push someone into a higher tax band.
He also warned that some pension withdrawals can accidentally reduce how much money people are allowed to save into pensions in future.
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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 guru also highlighted problems caused by emergency tax rules used by pension providers when someone takes taxable money from their pension for the first time.
He explained that providers may apply a temporary ‘Month 1’ emergency tax code which can result in people paying far 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.”
Although overpaid tax can usually be reclaimed from HM Revenue and Customs (HMRC), Martin suggested making smaller withdrawals or spreading payments across the tax year to reduce the risk of overpaying.
The warning applies to defined contribution pensions, sometimes called money purchase pensions, where workers build up a pension pot through contributions and investments.
Martin also warned that once someone takes taxable money from their pension, they could trigger the Money Purchase Annual Allowance (MPAA).
This reduces the amount most people can pay into pensions each year while still receiving tax relief from £60,000 to £10,000.
However, he explained there are exceptions.
Taking only the tax free portion of a pension does not usually trigger the reduced allowance and neither does using pension savings to buy a standard lifetime annuity.
How to track down a lost pension
1. Gather old job details
- Find the name of your previous employer or pension provider.
2. Use the Pension Tracing Service
- Contact the government’s free Pension Tracing Service to get the provider’s contact details.
3. Contact the pension scheme directly
- Ask whether you have a pension, how much is in it and what your options are.
4. Update your contact details
- Make sure the provider has your current address and email.
5. Consider consolidating
- Bringing small pots together can make pensions easier to manage — but check for exit fees or valuable guarantees first.
Martin also said people can usually withdraw up to three pension ‘small pots’ worth £10,000 or less without affecting future pension contribution limits.
He urged people to seek free guidance before making decisions about pension withdrawals.
People aged over 50 can book a free appointment with Pension Wise, while younger savers can get support through MoneyHelper.
Martin added that people with larger pension pots may also benefit from paying for independent financial advice to avoid expensive mistakes.
You can read the full guide on taking your tax-free lump sum from your pension pot on MSE.com.
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