THE arrival of the new tax year means millions of people are now able to take advantage of the much heralded pension freedom rules, writes Robert Little chartered financial planner at Bob Little & Co chartered financial planners. 

But I was shocked by the results of a recent survey commissioned by Sanlam Wealth Management suggesting 85 per cent of over-55s are unaware that liberating their pensions could land them an unwelcome letter from the taxman.

The key differences under the new system are the lifting of restrictions that were previously in place.

In a nutshell, these changes enable anyone aged over 55 who has a money purchase pension – including Personal Pensions and Stakeholder Pensions – to make withdrawals from their policy as and when they choose.

In the past, retirees were often forced into buying an annuity, so the new rules are a fantastic opportunity for many people.

Unfortunately, more opportunity often means tougher choices and sometimes unforeseen risks. The main issue that can arise is unexpected tax bills.

There are two main ways this can happen.

This article focuses on money purchase pensions only. Anyone with another type of pension (such as a final salary pension) should not be directly affected by the rule changes. Similarly, anyone who buys an annuity is unlikely to be affected.

The first issue is that any withdrawals taken from the taxable part of your pension will be added to your other incomes and taxed accordingly.

Importantly, you should be aware that the state pension is taxable. Even though it is paid to you without any income tax taken off, you will find that more tax gets taken off your other incomes.

The second issue is how the tax will be deducted. For some types of pension, providers are required to pay 25 per cent of the fund tax-free.

The other 75 per cent of the fund value will automatically have basic rate income tax – currently set at 20 per cent – taken off before it is paid.

This means non-taxpayers will be over-taxed and higher rate taxpayers will be under-taxed.

For other pension types the rules are more complicated. Essentially, any money taken from the pension will be treated as a monthly income and HMRC will assume you will keep receiving this each month. This works fine if you are truly taking a monthly income, but it will play havoc if you take a one-off lump sum.

The rules are very complicated and are wholly dependent on your circumstances. This is why so many people are expected to walk into a tax-trap where they will lose money unexpectedly, simply because they don't fully understand the implications of what they do with their pension.

As always, we recommend seeking advice from a professional if you have any questions.

Robert Little is a chartered financial planner at Bob Little & Co chartered financial planners, based in Prospect House, Kirkleatham Business Park, Redcar.