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10 Dec 2014

Avoid These Five Pension Pitfalls

The new pension freedoms announced in the Budget marked an important turning point for savers, suggesting more choice about how and when they can access their money than ever before.

But while the full details of the changes are still under consideration, it´s worth bearing in mind the pitfalls that could trip you up whilst saving for your retirement, Professional Adviser reports. Here are the top five drawbacks that those approaching retirement should be aware of:

1. Tax

Until April 2015, savers are able to take out up to three pension pots worth £10,000 or less as a lump sum. But bear in mind that this amount will be classed as added income, and therefore subject to income tax - meaning that you are unlikely to actually be handed a £10,000 cheque.

2. Becoming a high-rate taxpayer

As of April, there will be no limits to how much people can withdraw as a lump sum – and anyone over the age of 55 will be able to do so. But again, the majority of the pension pot is liable to income tax; therefore you could find yourself becoming a high rate taxpayer for the first time in your life, paying up to 40% tax. A safer method is to phase withdrawals and avoid the higher tax rate.

3. Make sure tax-efficient savings stay that way

While it might be tempting to withdraw a large cash lump sum - particularly if it´s needed for family or loved ones - this should be avoided unless completely necessary.

When left alone, pension pots are not liable to tax on capital growth or additional tax on dividends. This makes them very ‘tax-advantaged´, so it can be wiser to live off of your savings and leave pensions in their ‘tax-efficient´ protection. If you are still working, it´s better to leave drawing out your pension until you are put on a lower tax rate.

4. Length of retirement

More of a danger than blowing your savings on a shiny new car is the risk of underestimating how long your retirement could last. It could be 30 years or more, so get financial advice on how to manage your money over an extended period of time.

5. Personal tax allowance

Maximise your retirement income by taking all of your savings and investments into account, as well as the DC pension pot. View these as one large retirement account that can be drawn from in a much more tax-efficient way – minimising the amount of income tax you´ll pay.

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