Martin Lewis urges ‘avoid huge tax trap’ and spend pension ‘tax free’

Money expert Martin Lewis is urging people with pensions savings to avoid a ‘HUGE tax trap’ by taking the right amount of money out at the right time.

The financial guru was talking to pensions expert Charlotte Jackson, of the Pension Wise advice service, exploring ways his followers can save money on their pensions and legally avoid tax on their savings where possible.

Martin explained, with Charlotte’s help, how the timing of taking money out of your pensions - and the amount you take - can help you avoid tax.

Speaking on his Not The Martin Lewis podcast - a spin off of his regular episodes in which he invites experts on to talk about specialist areas - he said: “The big thing to understand when it comes to taking money out of your pension when you’ve got a pot of money built up, a lot of what’s worth thinking about is tax.

“You generally get 25 percent of the money in your pension tax free, and the rest is taxed.

“But what counts and when it’s taxed is when it gets complicated.”

Martin then advised his listeners to imagine their private pension pot (ie a pension saved up from work earnings - not the state pension) as like a giant swiss roll.

He added: “Most of the roll is sponge and you have your luxury jam bit in the middle. Well the sponge is the taxable part of your pension and the jam running through the middle, that’s your tax free amount.

“Now if you take your money out of your pension using it like a bank account, you get a slice of the swiss roll. And that swiss roll contains whatever amount you’ve taken from your pension, 25 percent of it is tax free, and 75 percent of it is taxed at your marginal rate, whatever income tax rate you’re paying.”

That means if you’re paying tax on your income at 40 percent - ie earning £50,270 or more - you will pay 40 percent tax on your savings. Earning between £12,750 and £50k and you pay 20 percent.

Martin continued: “But if you do what’s called a draw-down or annuity then you can just take the jam, you can take 25 percent of your pension totally tax free and you’re paid the rest via the draw down or annuity later when you take it.”

Martin said when you use a draw down, you can ‘take all the jam out’ when you want it, and the sponge is left to take down as an annuity later on when you choose to use it, perhaps when you no longer have income at all to pay tax on.

He added: “This allows you to control when you pay the tax on your pension pot. If later on in life you become a non-taxpayer, you take the rest out when you’re a non-taxpayer, you get a 25 percent lump sum now, and then when you take the rest of the money out even though it’s taxable, because you’re a non-taxpayer, it would be better for you.”