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The Hidden Dangers of Pension Liberation

Richard Beardsworth Pension Expert

By Richard Beardsworth.

Independent Financial Advisor

More Reading on Cashing In Pensions...

Pension liberation, also known as pension unlocking or pension release, is a means of accessing the cash in your pension fund before you retire. When done legally and wisely, it can represent an excellent opportunity to make good use of the money you have put away over the years. However, the opposite is also true. Illegal or poorly designed liberation schemes could cost you a significant amount of money.

There are a number of hidden dangers of pension liberation schemes that you need to be aware of. We have mentioned these dangers in other places on our website; now we will go through those dangers in more detail. This is information you need to know in case you are ever presented with an unsolicited offer to liberate your pension.

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Legitimate and Illegitimate Offers

To begin with, it is important to discuss the difference between legitimate and illegitimate pension liberation offers. A legitimate offer is characterised by three things:

  1. it does not subject you to tax penalties;
  2. it does not subject you to risky investments; and
  3. it does not promise tax-free money prior to age 55.

Any pension liberation scheme that does not meet these three qualifications is highly suspect. Therefore, it is incumbent upon you to understand how liberation works within the confines of the law.

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Punitive Taxation

The biggest hidden danger of pension relief is punitive taxation. Simply put, you could lose half of your money or more to taxation if the liberation scheme you choose is not in line with government rules. It is based on what is known as unauthorised payments.

Punitive taxation is assessed on any payments you receive from a liberation scheme prior to age 55. There are only three exceptions to this rule: a health condition that forces you to retire, a grave illness that has reduced your life expectancy to less than one year, and participation in an exempt pension scheme offered prior to 2006. In the absence of one of these exceptions, unauthorised payments from your pension plan will result in a minimum tax of 55%.

This means a liberation payment of £5,000 would result in a tax bill of at least £2,750. Nevertheless, it gets worse. If you fail to notify the Government of your pension release, or you purposely try to hide it, your tax bill could go up to 70%. That is far too much to pay just to liberate your pension prior to age 55.

Excessive Administrative Fees

Liberating a pension involves participants on both sides of the transaction. On the one hand is the administrator of your current pension who will charge you certain fees to cover administrative expenses. In some cases, these fees are minimal; in other cases, they could be quite substantial. On the other end of the transaction is the individual or firm you are working with to complete the pension liberation. Here is where you could get into real trouble.

The next hidden danger of pension liberation comes by way of shady firms or individual advisors who:

  • charge excessive commissions;
  • put your money in non-qualified investments; or
  • steal your money outright.

Poor Future Performance

Are you considering liberating your pension for the purposes of investing your cash somewhere else? If so, you need to be aware that one of the hidden dangers is poor future performance. You may not earn the kind of money you are expecting, leaving you worse off than when you started.

Let's just say you decided to take some cash out of your pension and put it into the Forex market. If you don't know what Forex is, it is a market for exchanging currencies. There is a lot of money to be made in this market for those who know what they are doing. If you don't know what you're doing, you could lose a lot. Liberating a portion of your pension in order to invest in the Forex market should only be done under proper advisement.

You might also liberate your pension for the purposes of using the money to pay monthly bills. Nonetheless, doing so is not necessary if you are at least 55 years old. Instead, you could leave the money where it is and declare a draw down contract instead. This would still enable you to use the money to pay monthly bills while allowing the funds remaining in your scheme to continue earning a return.

Running out of Money

Another hidden danger of pension liberation is running out of money before you die. This is a very real possibility we Britons do not tend to think about very often. In fact, we have a very poor reputation for making sure we save enough for retirement. Why risk everything you saved by taking advantage of an ill-advised liberation scheme?

The Money Advice Service deals with the topic of pension liberation at great length. One of the things they discuss is working out how much money you will be left with in retirement if you decide to take money out of your pension early. Obviously, this refers to withdrawals taken after you reach 55. The more you take now, the less you will have when you eventually do retire.

Overdependence on the State Pension

The last hidden danger of pension liberation is that it can cause people to develop unrealistic expectations about the state pension. Trust us when we say that overdependence on the state pension is a recipe for disaster. What you receive from the state once you retire is not going to be enough to sustain you.

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At the current rate, the basic state pension pays £119.30 per week for an individual recipient. You could receive less under certain circumstances. That means your annual income from the state pension would be no more than £6,203.60 at the current rate. There are different rules if you live abroad.Bottom of Form

Can you live on £6203.60 per year? If you are married, can you and your spouse live on £12407.20 per year? With the cost of living these days, it is hard to imagine anyone can survive on such a small amount. It is not wise to liberate your pension if there is even the slightest possibility it could leave you depending on your state pension for the majority of your retirement income.

Pension liberation does offer you a way to access the cash in your pension fund, without penalty, once you turn 55 years old. However, the fact that you can access the money does not necessarily mean you should. As we have demonstrated, there are enough hidden dangers of pension liberation to suggest you be very cautious.

As always, seek out the free government guidance available through Citizens Advice and other agencies as well as qualified advice from an authorised financial advisor. It could mean the difference between a comfortable retirement and living your last few years in poverty.

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