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Thinking of accessing your pension before age 55? Be very careful
It can be tempting to try and take money from your pension to help you out financially at a difficult time. But this is not always wise. Here we consider some of the punitive tax issues that may arise as well as actions you may take to protect yourself. The guidance here relates to UK registered pension schemes but we make a brief mention of the state pension at the end.
Why should tax bother me when I draw my pension?
UK law gives generous tax reliefs both when paying in to your pension and to minimise tax charges while your pension fund remains untouched. Also, normally when a pension starts to be paid, 25% of the fund can be taken tax-free. That lump sum is calculated slightly differently if you are in a defined benefit pension scheme, but is still generous. Any other amounts taken from the pension fund as income are taxable. Note that different rules apply if the ‘owner’ of the pension dies and the pension is paid to someone else.
These tax perks come with conditions, one of which is that normally there should be no withdrawal before age 55 (proposed to rise to age 57 from 2028). Early withdrawal can mean a significant tax charge arises and, because reputable pension schemes would not allow such an early withdrawal, it is likely you are being scammed and may lose a large part of your pension fund.
When might I take money from my pensions early without suffering an excessive tax charge?
Normally your pension fund can’t make any payments before you reach age 55 unless you are seriously ill or are expected to live for less than a year. In those circumstances you may be able to withdraw funds early without suffering a large tax charge.
Also, there are some older pension schemes (schemes that started before 2006) where it was possible to take a pension before the retirement age at that time (50). These schemes were for specific occupations such as sportspeople or entertainers. The earlier retirement dates allowed for these pension schemes have remained unchanged. Your scheme provider will be able to tell you if you have one of these special types of pension.
I’m not seriously ill but I’ve been told I can take my pension funds now – is this right?
If you’re not in a special type of pension scheme (see question above), then drawing out your pension before age 55 would normally not be allowed under the scheme rules. These would be classed ‘unauthorised’ payments.
What is likely to be happening is that you are being encouraged to transfer your pension fund into another type of pension scheme that does allow such unauthorised payments – but you need to be aware that this is likely to result in a very substantial tax charge of up to 55% of the value withdrawn.
The organisation arranging the transfer is also likely to charge you a significant fee. You may end up with very little in your hands while the organisation that has ‘helped’ you ends up with more of your pension fund than you are left with.
How can I check out whether what I am being offered is a scam?
Read the descriptions of various scams on the Pensions Advisory Service website. You should also check that the person or organisation advising you is properly regulated as this gives you some protection if things go wrong. You can check them out on the website of the Financial Conduct Authority.
Be especially careful if the returns being offered on any investment seem much more attractive than are being offered elsewhere or if the plan is to move your pension funds offshore (overseas).
As explained on the Financial Conduct Authority website, you can also report any such scams.
I think I have been the victim of a pensions scam but I haven’t received any money yet. What should I do?
It is possible your original pension scheme hasn’t yet made the transfer. Contact them urgently and ask them not to make the transfer.
As explained under the question above, follow the Financial Conduct Authority guidance on reporting scams.
I took my pension before age 55 and have now got a large tax bill. What can I do?
First, check the figures that HMRC have provided you with. You should know how much you actually got from your pension scheme. Typically you would not receive the full amount of the unauthorised payment because a large amount may have been taken as a ‘fee’.
Your pension fund was worth £20,000. You were persuaded to transfer the pension and then take a payment from the scheme. You actually received £15,000 – in other words the ‘scammer’ took £5,000. HMRC would base the tax bill on the full £20,000. The 55% tax charge amounts to £11,000. So you have been left with just £4,000 (£15,000 - £11,000) after fees and taxes. And you now have no pension fund.
When you receive the bill from HMRC (the assessment) you can appeal against it if the figures are incorrect. If you were not expecting the tax charge, you may find it difficult to pay the sum requested, even if it is based on the correct amount. We recommend you approach HMRC and explain the situation thoroughly, requesting that they consider using their care and management powers to reduce the sum on which the tax charge is based. For instance, in the example described above, you could explain that you actually received only £15,000 of the £20,000 total unauthorised payment.
You need to appeal the assessment within 30 days of it being issued. HMRC are likely to consider your whole financial situation and are under no obligation to reduce the tax charge. When you appeal the assessment you can also apply to postpone the tax due, but be careful because that could mean that you incur interest charges on any tax remaining payable.
HMRC may offer you the possibility of paying any tax charge in instalments if that best suits your financial situation and you should ask for that facility if you will be unable to pay in one instalment.
Can I get any of my money back?
For people who have lost defined benefit pensions, the High Court found in November 2020 in the Dalriada case,  EWHC 2960 (Ch), that it is possible for compensation to be paid from the Pension Protection Fund’s Fraud Compensation Fund.
We understand that it would be the pension fund which would be eligible to apply for compensation, but this might mean – if they are successful – that they could pay out pension benefits to you from the compensation.
At the time of writing, not much information is available about how this could work in practice, so we would suggest you contact your pension provider if you think it might help you. Note, though, that the ruling only applies to defined benefit schemes – those which promise to pay you a certain pension based upon your earnings and years of service with an employer. If you have been scammed out of, say, a personal pension, it does not apply.
Where can I get extra help to understand my tax position on an unauthorised pension payment?
The charity TaxAid can assist you where you are on a low income and have already tried to resolve the matter with HMRC.
Can I take my state pension early?
Where can I find out more?
Earlier this year, we wrote some guidance for people considering taking money from their pension as a result of coronavirus. This provides links to our other guidance with more detail, so it’s a good place to start for further reading.
Contact: Gillian Wrigley (click here to Contact Us)
(First published: 07/12/20)