You may not have heard of pension dippers, yet there are a lot of them.
They are people who use the pension freedoms to dip into their retirement savings.
A total of 260,000 took a taxable pension payment in 2020, according to analysis of tax office figures by the insurance company Just.
That brings to 1.6 million the number who in the past five years have become subject to stringent tax rules of which they may have been ignorant.
Pension dipping gives you control of your money but there are consequences. Once you have dipped into your pot, the amount you can pay into it and claim tax relief on reduces from £40,000 a year to £4,000.
You can also be hit with a large tax bill because after the 25 per cent you are allowed to take free, any amount withdrawn is at your marginal income tax rate.
On the one hand, it means people are using their savings as and when they need them, which is good. On the other hand, some will end up draining their retirement funds and face the possibility of a drastically reduced standard of living in old age, which is very bad.
For those feeling the pinch through the pandemic, raiding the pension pot has proved an easy way of accessing money in a hurry. Sadly, many will not have bothered to seek financial advice, unaware that this could put a serious dent in their post-retirement income.
The website Love Money cautions: “Not only will you have reduced the overall capital in your pension, but you are also reducing your future growth as there is less invested.
“Make sure you do your sums and can afford to lose that money from your pension before you grab it.”
You are sacrificing vital compound interest.
So, before acting, ask yourself – do you want to continue paying into your pension after you’ve taken some money out of it?
Of the thousands in the over-55s category who activated a reduction in their annual allowance last year, how many realised the wider implications. That is the big question.
Just Group suggests many dippers will regret their pension largesse.
Stephen Lowe, a director at the firm, said: “Taking a flexible payment is fine if you understand the rules and it is part of your financial plan.
“But many people will not have pored over the small print of the tax rules or understand the extra administrative responsibilities. Those who simply dipped into their pension to get them through a tough patch, intending to make up their pension savings later could be in for a nasty surprise.
“The idea that you have the freedom to use your pension like a bank account – paying in or drawing out when you want without any knock-on consequence – is simply not how the system works.”
Triggering what is called the money purchase annual allowance (MPAA), and hence the £40,000 to £4,000 equation – brought in largely to clamp down on the recycling of pensions tax relief – can have a severe financial impact on those who had hoped to continue working and building their retirement funds, say experts.
Nathan Long, senior analyst at Hargreaves Lansdown, told the Financial Times: “Someone accessing their pension in their fifties could be working for many years to come. Those who manage to get back into work could face the very real prospect of having to give up pension contributions from their employer to stay inside the limit.”
If you were fortunate, you didn’t catch Covid. If you were unfortunate, you caught a cold from pension dipping.
It’s a tough life!