New research shows how people withdrawing their pension in one go could pay a lot of tax for the privilege.
One in 10 people will take their pensions in one go next year when the new pension freedoms are introduced, potentially racking up a huge tax bill.
Research by investment company Hargreaves Lansdown suggests that 200,000 people aged 55 or over will take their pot as soon as they can.
And it says this could net the Treasury as much as a whopping £1.6 billion in tax, depending on the tax rate people are charged.
Hargreaves Lansdown estimates the median pension pot is worth £29,000.
New tax rules
The new rules allow you to take all of your pension in one go, with 25% of that tax free. Then most people will have a tax-free personal allowance of £10,500.
The rest is charged at what’s known as your marginal rate, which is either 20%, 40% or 45%, depending on your income.
However, by withdrawing a reasonable-sized pension in one go, some basic rate (20%) taxpayers could end up paying 40% tax on it.
For more on the reforms, have a read of Why pensions are now the best way to save.
See if you're on track for the retirement you want at a glance with lovemoney's new Plans service
Some examples
Hargreaves Lansdown has looked at the tax bills for three different people with different-sized pensions and different tax rates.
George earns £20,000 a year and cashes in a pension worth £30,000. Taking account of his personal allowance, his tax-free lump sum entitlement and his existing income, George will pay a top rate of 40% tax on his pension and suffer an effective tax charge of 15% on the pot overall, costing him £4,627.
[SPOTLIGHT]Steve earns £30,000 a year and is cashing in a pension pot of £90,000. He’ll end up paying a top tax rate of 40% and an overall effective tax rate of 27% on his pension fund, costing him £24,627 in tax.
David earns £40,000 a year and has a pension pot of £300,000. David will pay a top rate of tax of 45% (though he’ll suffer an effective tax charge of 60% due to the loss of his personal allowance) and an overall effective tax rate of 32% on his pension pot as a whole, costing him £95,750 in tax.
So you can see that for people with larger pension pots, the tax charges for taking the lot are going to be big.
See if you're on track for the retirement you want at a glance with lovemoney's new Plans service
The knowledge gap
When Hargreaves Lansdown asked people about the likely tax implications of taking all of their pension at once, only two in five could say accurately how much tax would be charged on a medium-sized pension. And less than one in ten could correctly predict how much tax would be paid on a large pension.
The dangers of taking it all at once
When the pension freedoms were first announced there were a lot of headlines about pensioners blowing all their money on fast cars and expensive holidays.
However, the reality is managing your money in retirement is a tricky business, as most of us have no idea how long we’re going to live.
Research by specialist insurer Partnership found that many women significantly underestimated how long they would live for, compared to official projections.
See if you're on track for the retirement you want at a glance with lovemoney's new Plans service
More on pensions and retirement:
Why pensions are now the best way to save
How to work out how much you need to save for retirement
ILC: UK has one of the least generous state pensions in Europe
UK pension pots will run out in just five years
Couples over 40 failing to make financial plans for retirement