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5 traps pension rules banner

5 traps hidden in
pension rules

More than 625,000 pension investors have taken advantage of the freedoms since launch, but are there any pitfalls lurking within them?

Pension changes factsheet download

Avoid these possible traps at retirement

Pension investors now have far greater flexibility with their pension savings at retirement. More than 625,000 pension investors have taken advantage of the freedoms since launch in April 2015, taking over £10.8bn from their pensions. But are there any pitfalls lurking within pension freedoms?

Here we highlight some of the traps hidden in these freedoms and how you could avoid them.

  • Turning into a higher rate tax payer overnight
  • The risk of a fine from HMRC or restrictions on future contributions
  • Becoming reliant on the state in your retirement
  • Missing the opportunity to take advantage of pension freedoms

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1. You could turn into a 45% income tax payer overnight

From age 55 (57 from 2028), you'll usually be able to take up to a quarter of your pension as a tax-free lump sum. This tax-free cash is yours to spend or invest as you wish. You can then take as much as you like from the remaining pension, even the whole lot if you wish. However these withdrawals are taxable. It was estimated “the pension freedoms” introduced in April 2015 would net the Treasury an extra £3 billion in tax receipts in the first four years.

The withdrawals you make will be added to the rest of your income in that tax year, and subject to income tax at your highest rate. So, they could push you into a higher tax bracket. At the extreme, you could instantly face being a top-rate tax payer (45%) if you make a withdrawal which, combined with your other income, takes you over £150,000.

Worse still, it's likely this payment will initially be taxed at the emergency rate if this is the first time you are taking a lump sum or income from your pension, which increases the likelihood that you’ll over-pay tax and have to reclaim it from HMRC.

There’s another potential pitfall, too. Your personal allowance (the amount of income you can receive without paying tax - which for most people is £11,500 in tax year 2017/18) narrows once your income exceeds £100,000. It reduces by £1 for every £2 of income over this amount. So, if your taxable income is between £100,000 and £123,000 this tax year, you might effectively be subject to income tax of up to 60%.

Tax rules can change and benefits depend on personal circumstances.

How to avoid the trap

  • Don't take large withdrawals all at once. If you can stagger your withdrawals over different tax years, you could reduce the tax you pay.
  • You could use some of your tax-free cash to supplement your taxable income in the early years.
  • Pensions can shelter your savings from tax until you take that money out (for instance you don't pay further UK income tax or UK capital gains tax on the income or growth from your investments, and in most cases your pension is exempt from inheritance tax). It can make sense to keep this tax-efficient status going for as long as possible. There are also more options for passing on pension wealth when you die, tax free in some cases.
    Free factsheet download: what happens to your pension when you die

Free factsheet: How will my pension be taxed at retirement?

Income tax calculator

See the impact on your tax liability if you take a lump sum from your pension.

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How to save tax in retirementSeven tax saving tips. Download your guide

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2. You could run out of money and become reliant on the state

This is possibly the most dangerous trap of all, as you may only notice its bite once it's too late to do anything about it.

A pension is designed to provide income in retirement, which could last for 30 years or more. If you blow all your pension savings in the early years, or even unwittingly draw an income which is not sustainable over the long term (for instance if you keep your fund invested and it does not perform as well as you expect, or you take excessive withdrawals), your pension might not last as long as you do.

Few will want to be reliant on the state in their old age. Don't underestimate your life expectancy (82% of the population seriously under-estimate this, according to industry research), nor downplay how much money you are likely to need to last your retirement.

How to avoid the trap

  • Why not set up a safety net by using some of your pension to buy a secure income for life? Whilst some may see this as boring and pedestrian, this will never run out and can be used to pay essential living costs, which have a tendency to keep going (and increasing) through retirement.
  • If you are taking income directly from the pension fund, via drawdown for example, keep this under regular review to ensure you are on track, and consider just taking the income generated by the investments themselves. This is known as drawing the ‘natural yield’. Income can fluctuate and is not guaranteed.
Calculate what income could be sustainable using drawdown

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3. You may be ready, but your provider might not be

There is no legal obligation for providers to offer the freedoms introduced in April 2015. Some firms offer all the freedoms but others don't.

How to avoid the trap

  • If you want to take advantage of the pension freedoms, why not consider transferring your plan to a provider who allows you to do so? One example is Hargreaves Lansdown.
  • Investors in the Hargreaves Lansdown SIPP (Self Invested Personal Pension) are able to take full advantage of the flexibilities, including drawdown and lump sum withdrawals. Before you transfer, please ensure you won't lose any valuable guarantees or benefits or incur excessive exit fees.

Transfer to the Vantage SIPP

The Vantage SIPP offers you control, a wide investment choice and you can manage it online. There are no transfer in charges and we do all the transfer work.

Find out more about transferring to the Vantage SIPP

Important information: SIPPs are a type of pension for people happy to make their own investment decisions. Investments go down in value as well as up so you could get back less than you invest. The rules mentioned are those currently applying and could change. You can normally only access the money from age 55 (57 from 2028). Tax rules can change and benefits depend on individual circumstances. This website is not personal advice, if you are unsure an investment is suitable for your circumstances please seek advice.


Even after taking benefits you can still transfer your pension to a provider which best suits your needs.

You can transfer most types of pension to the Vantage SIPP, normally without needing advice.

Find out more about transferring a pension

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4. You could restrict future pension contributions, and possibly get a fine from HM Revenue & Customs

Most people will have a standard annual allowance of £40,000 when it comes to how much they can contribute to their pensions, and still receive tax relief. However once you flexibly access pension income, via drawdown or as a lump sum for example, the amount you can contribute to defined contribution (e.g. personal or self invested) pensions is limited by the money purchase annual allowance - MPAA. This is £4,000 for tax year 2017/18. Taking tax-free cash alone will not trigger the MPAA.

Savers are required to notify all the defined contribution pension providers with whom they are building up benefits should they start to take an income and trigger the MPAA.

The rules require the investor to notify all such pension providers, so that provider can apply the lower contribution limit introduced from April 2015. They need to do this within 91 days of receiving a certificate confirming they have taken flexible pension benefits or start to build up benefits in the plan if later.

If they don't meet this deadline the investor could be hit with a fine of up to £300.

This rule could involve liaising with multiple pension providers if you are still paying into the plans you hold with them.

How to avoid the trap

  • Maximise contributions before you start to take lump sums or income.
  • As soon as you start to take lump sums or income out of your pension, make sure you notify any other pension providers to which you are still contributing.
  • You might consider consolidating all your pensions in one place, to avoid you having to notify multiple providers.

Free factsheet download: Lifetime allowance protection

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5. Avoid rushing into any decision

Don't feel you have to rush into a decision. Take your time. Find out your options and ask for an explanation of how things work in plain English. Some of the options are extremely flexible, but due to the risks involved you could make a significant loss, for example if investments were to perform poorly. At the other extreme, some options can't be changed once they’ve been set up, so you could be locked in for life. Check the small print and shop around.

How to avoid the trap

  • Read around the topic and ensure you understand your options. Remember you can mix and match the options to suit your needs. If you don't understand, or are unsure of the suitability of any investment for your circumstances, seek financial advice.
  • Hargreaves Lansdown has a range of guides - why not take a look? Or call one of our retirement specialists on 0117 980 9940 - we can also put you in touch with an adviser if you are not sure about what to do.

What help is available?

What you do with your pension is an important decision. Therefore, we strongly recommend you understand your options and check your chosen option is suitable for your circumstances: take appropriate advice or guidance if you are at all unsure.

Pension Wise, the government's pension guidance service, provides a free impartial service to help you understand your options at retirement – Find out more about Pension Wise

This article, our guides and online tools, are not personal advice. We offer a range of information and support to help you plan your own finances. We also have an award-winning team of Financial Advisers who can help you achieve your goals. Our flexible approach means you only pay for the advice you need.

If you have any questions, please call our experienced Retirement Helpdesk on 0117 980 9940 (Monday to Thursday 8am - 7pm, Friday 8am - 6pm and Saturday 9:30am - 12:30pm), you will speak to a real person who will answer your questions in plain English.


The government’s Pension Wise service can help. Pension Wise provides free impartial guidance on your retirement options face-to-face, online or over the phone.

More about Pension Wise

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