The government is planning to cut permitted tax-relieved pension contributions for those taking benefits flexibly.
While the Autumn Statement was light on pension reform, it did contain details of a change that could harm the prospects of working individuals who use pension flexibilities to their advantage.
Pension freedoms, introduced in April 2015, gave individuals over the age of 55 unrestricted access to their defined contribution (DC) pension savings. As a consequence, it also gave working individuals in that age bracket the ability to put their earnings into a pension and then take that money back immediately. As 25% of a pension withdrawal is tax-free, one quarter of the tax ordinarily due on those earnings was not payable.
Understandably, the government was keen to restrict how much savers could benefit, so it brought in the ‘money purchase annual allowance’ (MPAA). Under these rules, if someone wished to make further contributions after taking their DC pension benefits flexibly, they were subject to the MPAA and restricted to making maximum pension contributions of £10,000 a year net of tax relief.
Now the government wants to go further and is seeking views on cutting the MPAA to £4,000 with effect from April 2017. If rubber-stamped, the reduced MPAA will further limit people’s ability to invest their earnings, tax-free, into a pension whilst also drawing on their existing DC pension savings.
In documents published in November, the government said that circulating money in the way described above was “not within the spirit of the pension tax system” and that it believed that an allowance of £4,000 was “fair and reasonable and should still allow people who need to access their pension savings to rebuild them if they subsequently have opportunity to do so.”
But Ian Price, Divisional Director at St. James’s Place, believes the lower allowance has the potential to seriously damage the retirement prospects of those who look to combine work with drawing a pension – a segment of society that is expected to grow.
“Some individuals may need to draw on their pension flexibly, but then find that they want to work again and make significant contributions to their pension. Unfortunately, it will be harder for them to rebuild their pension with a lower MPAA,” he says.
Price also believes that it is unfair to move the goalposts for anyone who made plans based on the existing rules.
“If someone has taken cash from their pension under the new freedom rules – to pay off the mortgage, for example – they might have done so with the understanding that they could still make contributions of up to £10,000 to their pension each year.”
Someone triggers the MPAA when they access a DC pension through ‘flexi-access drawdown’, whether or not they have also taken their tax-free entitlement; or when they first take a cash withdrawal (also known as an ‘uncrystallised funds pension lump sum’), one quarter of which is tax-free.
Importantly, the MPAA is not triggered when someone takes only their tax-free entitlement and leaves the rest of their fund untouched. Similarly, it is not triggered when someone purchases an annuity that pays a fixed income for life. Nor is it triggered when someone cashes in up to three separate small pension pots of less than £10,000 each.
“The MPAA is only an issue if you take taxed income,” says Price. “If you are just taking the tax-free cash then you are not caught.”
“If you are thinking of accessing your pension before taking full retirement, it makes sense to talk to your financial adviser – there are a few ways of avoiding the MPAA,” he says.
Anyone who is subject to the MPAA, and still saving into a pension, might want to consider investing the full £10,000 allowance before the end of the tax year.
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