Tens of thousand of savers face paying unexpected tax bills and HMRC fines because they do not understand the rules around pension freedoms next year, new research shows.
Annuity provider MGM Advantage warns thousands could be pushed into the higher tax band and face self-assessments for the first time without understanding the rules.
The average pre-retirement salary is £33,288, while Association of British Insurers statistics show 120,000 annuities were sold to people with pension pots between £10,000 and £30,000 last year.
MGM argues that if savers on the average salary take more than £10,000 in a lump sum, beyond the 25 per cent tax-free amount, they will be liable for self-assessed income tax in the higher band.
But MGM research shows six in 10 people aged over 55 do not understand the tax issues around pension withdrawals.
When the tax issues are explained then 83 per cent of savers would choose to leave their money in a pension wrapper and draw an income as needed, rather than taking the entire pot as cash in one go. However, 17 per cent would pay tax on any withdrawal.
If taxpayers miss the deadline to file a tax return HMRC will charge a penalty of £100. If it is more than three months late then a penalty of £10 a day is added for up to 90 days giving a maximum of £900.
In serious cases beyond 12 months HMRC can also demand up to double the original tax bill.
Savers are also facing HMRC fines of £300 initially and £60 a day if they do not inform their other pension providers of withdrawals within 31 days. Fines of £3,000 can also be dished out for wrong information.
MGM Advantage pensions technical director Andrew Tully says: “The pension freedoms bring a new level of complexity and choice in how people access their pensions. One of my concerns, even with conservative estimates, is that many people could find themselves being dragged into the higher tax bracket and the self-assessment tax system for the first time.
“This could mean people either pay too little tax or too much tax, as well as the potential for hefty fines from HMRC for people who don’t complete their self-assessment on time.
“Once you’ve taken the money, you can’t change your mind. This is an irreversible decision from a tax perspective, and could leave people wondering why they receive a tax bill further down the line. They may then not have the money available to pay their tax bill.
”Our research shows that the awareness of the tax implications of pension lump sum withdrawals is low, so there is a clear danger of people making ill-informed decisions. At a time when people have access for the first time to possibly the largest single sum of money in their lives, well-informed decisions based on the facts will be crucial in ensuring good customer outcomes. Proper financial advice will play a key role.”