Beware these four pension pitfalls

Harvey Jones

Considering cashing in your pension? You must know about these four threats first. 

When the over-55s were given the freedom to cash in their pension pots last year, the death of the annuity seemed nigh.

An annuity is the 'income for life' that savers were forced to buy with their pension, but plunging rates left many complaining of being forced into a poor deal.

Chancellor George Osborne liberated people to take their pension as a cash lump sum from April 2015, or else leave it invested via income drawdown and take money when they need it.

Annuity sales instantly collapsed as tens of thousands of savers seized on their new "pension freedoms", with roughly half choosing to take the cash, often without taking advice first.

It isn't hard to see the attractions of cashing in your pension but four serious threats have since become apparent.


1. Tax shock

tax shock

Freedom comes at a price. Although 25% of any withdrawal is free of tax, the rest is subject to income tax.

A 20% taxpayer who took a large lump sum that pushed them into the higher-rate tax bracket for that year could then pay 40% tax on some of the cash, depleting their savings.

They might have avoided that altogether by drawing small, regular amounts year after year, say, through a lifetime annuity.


2. Fraud fear

Once you have cashed in your pot the pension company can no longer protect you from swindlers.

Thousands have already been ripped off by con-artists hard selling dodgy investment schemes.


3. Cash crash

cash crash stock market

Stock markets have been volatile lately and this could hit those who leave their money invested via income drawdown, as they cannot draw as much income from their reduced pot.


4. Spending the lot

The final danger is that people who cash in their pension will manage it badly and run out of money, plunging them into poverty.

As life expectancy grows, so does the danger that your money won't last.

An annuity is the only product that guarantees to keep paying out, even if you live to 100 and beyond.


Choose wisely

choosing pension

This isn't an all-or-nothing decision. If your pension is large enough, you could cash in some of your pot and use the rest to buy an annuity.

If you do buy an annuity then shop around for the best deal. Two out of three retirees simply take what their pension company offers them, and often get a worse deal as a result.

Also, check whether your pension scheme offers you a guaranteed annuity rate, which may be dramatically better than anything you could get in today's low-interest rate world.

The Government-funded Pension Wise service offers free basic guidance to the over-50s, but these are complicated decisions and you should consider taking independent financial advice as well.