Picking on pre-pensioners may mean taxman trouble

flickr user scottwills' nest egg

As we all know, savings rates are at an all-time low, and this couple with high inflation is hitting those on fixed incomes, like pensioners, hard. In fact, it has been reported that people in the UK have collectively seen the real value of their savings drop by between £29.42 and £36.45 billion during the past year, depending on which measure of inflation (RPI or CPI) is used.

But if making ends meet weren’t hard enough, a new ‘scheme’ has come on the market, aimed at those struggling to make ends meet, but who may have put something away for their retirement. It’s called pension unlocking, and it allows you to gain access to your pension fund before you are allowed to gain access to your pension fund at age 55.

It already sounds dodgy doesn’t it?

Basically, you give your pension fund to one of these specialist providers, who will then loan you money based on the value of your fund. Normally you can access about 50% of your fund as a loan before retirement.

However, the Financial Services Authority has issued an information sheet warning consumers about this type of scheme. Not only will you face hefty charges from the loan providers that will further reduce your pension fund value, but you may end up in shtuck with the taxman too.

Basically, the ‘information’ provided to customers does not actually tell you exactly how much it will cost you to do it, nor what loan repayments (including interest) will become due and payable from the remaining balance of your fund. The FSA suspect that you will not end up getting the benefit of the full value of your fund. We think that’s putting it politely.

Also, these schemes claim that you can get this cash tax-free as it is a loan, rather than pension income. The FSA and HMRC are a little more dubious.

In simple terms, income taken from a pension on retirement is normally taxed as earned income, much the same as employment income. Even if you consider that you may be able to withdraw up to about 25% tax-free as a lump sum on retirement, this will not be enough to cover repaying a 50% loan, not to mention the compounded interest and charges levied thereon. And that is assuming that whatever these providers do with your pension fund means it is still treated as such. The FSA, HMRC and the Pensions Regulator are investigating these schemes mindful of the fact that unauthorised payments from a pension fund (such as those taken before retirement age) could be subject to a penalty tax charge of 70%.

It doesn’t take a mathematical genius to work out that a 50% loan plus 70% tax plus unquantifiable fees and charges adds up to a worse financial position, rather than a better one.

Besides, if you access and spend all your retirement savings now, what are you going to live on when you retire? As the FSA put it “early access to pensions is rarely in anyone’s long-term financial interests.”

If it sounds too good to be true, it probably is. Someone will be better off if you use this scheme, but it probably won’t be you.

What do you think?

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