(Bloomberg Opinion) -- Last week the U.K.'s Office for Budget Responsibility revised its forecast for tax revenue from people accessing their pensions. After collecting a mere 400 million pounds ($525 million) last year, it was expecting a figure of 1.7 billion pounds for the tax year ending April 5.
More than 650,000 Brits aged 50 to 70 have stopped working since the pandemic began. The drastic increase in pension tax receipts suggests that many of the them are now trying to shore up their finances by accessing their pensions sooner and more aggressively than they had perhaps previously planned.
This is clearly not a sustainable financial strategy over the longer term. However, once the cause of the financial stress is understood, there are several things that those facing both premature retirement and precarious finances can do.
Over-50s suffer from the double whammy of being more likely to be made redundant than younger workers and less likely to find alternative jobs later. Since the government's furlough scheme started to wind down last July, the redundancy rate for over-50s has been more than 45% higher than for 35–49-year-olds, according to data from the Office for National Statistics. Historically, the redundancy rates for these two age groups have been roughly similar.
At the same time, the Centre for Ageing Better charity found that even before the pandemic, only one-third of over-50s returned to work within a year of redundancy compared to 54% for 35–49-year-olds.
As in most countries, pensions in the U.K. are tax-efficient vehicles for those saving for retirement. Certain tax advantages also accrue upon withdrawal. As a rule, you can withdraw up to 25% of your pot entirely free of tax once you reach the age of 55. What often trips up the unwary, though, is that any withdrawals beyond that tax-free allowance are taxed in the same manner as regular income. It is certainly not tax-efficient to withdraw most, still less all, of your pot in one go, as it appears many recent retirees have been doing.
A simple example illustrates the point. A 55-year-old, higher-rate (40%) income taxpayer made redundant mid-year might already have exhausted their zero and basic-rate (20%) tax allowances. Therefore, withdrawing the entirety of a 100,000-pound pension pot (perhaps to pay off a now unaffordable mortgage) could easily result in a tax bill of 30,000 pounds .
Typically, careful planning can help reduce a retiree's pension tax bill to zero if they have no other form of income. If you have the luxury to wait until the new tax year, you could withdraw 37,570 pounds in the first year entirely tax-free, thanks to the 25% pension tax allowance and the 12,570-pound annual income tax allowance. Thereafter you could withdraw 12,570 pounds a year entirely free of tax, assuming the annual income tax personal allowance remains at that level, saving 30,000 pounds in the process.
How much of the recent bumper pension tax payment is due to not knowing the tax rules, rather than financial distress, is difficult to say at this stage. However, the sudden, and largely unexpected, jump in credit-card borrowing in the U.K. indicates at least an element of people being forced to take expensive actions to meet short-term liabilities. The Bank of England reported last week that credit-card borrowing had jumped to its highest level on record in February (almost 60 billion pounds), even as consumer confidence plunged back down to 2020 pandemic levels.
To make matters worse, many of those forced into unemployment in their late 50s are not eligible for Universal Credit, the catch-all U.K. low-income benefit, if their assets exceed the 16,000-pound threshold.
If you're thinking about tapping your pension early, first consider a couple of other things you can do. For example, you might be eligible for a benefit called the Jobseeker's allowance. And even if you are not eligible for Universal Credit, you should still be able to get a National Insurance credit to bolster your state pension entitlement. This is generally free if you are unemployed, but it is not automatic. You must apply for it separately.
Of course, the best retirement-planning tool is having a job. A survey by investment manager Abrdn underlined this point: Of people planning to retire in 2022, more than 65% intended to continue with some form of employment after retiring. This is almost double the rate prior to the onset of the pandemic in 2020.
The U.K. government scrapped the default retirement age in 2011, meaning that your employer cannot force you to retire at a certain age. So, if you fear that the perfect storm of inflation, falling markets and inadequate savings has made retirement unaffordable, you hopefully still have the option to extend your working life. It might not be ideal, but it is better than the alternative.
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The first 25,000 pounds withdrawn would be tax free due to the 25% allowance. The remaining 75,000 pounds would be taxed at 40%, resulting in the 30,000-pound tax bill.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Stuart Trow is an investment strategist, most recently at the European Bank for Reconstruction & Development. He is a financial coach, co-host of “Money, Money, Money” on Switch Radio and author of “The Bluffer's Guide to Economics.”
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