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Irreversible tax warning as thousands access pension pots each week

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31/10/2022
Nearly 150,000 pension savers aged 55 and over have dipped into their retirement pots this year, but many may not realise they’ve triggered irreversible tax rules impacting their future income.

During the first six months of this year, 148,000 people aged 55 and over took their first ‘flexible payment’ from a pension, opening them up to complex rules to curb tax relief on future pension contributions.

A ‘flexible payment’ means that people accessed a pension worth more than £10,000 for the first time, and took more than the 25% tax-free lump sum allowance under pension freedom rules.

To date, around two million people have accessed their pension pots under the freedoms introduced in 2015, and each working day, around 1,200 extra dip into their retirement savings for the first time, triggering the Money Purchase Annual Allowance, according to analysis of HMRC figures by retirement specialist, Just Group.

Money Purchase Annual Allowance

The pension annual allowance is the amount of money you can pay into your pension pot every year where the amount gets tax relief.

Ordinarily, the maximum tax-free amount that can be deposited into a defined contribution pension stands at £40,000 a year (or 100% of your earnings if lower).

But for those aged 55+ accessing pensions flexibly for the first time, this triggers the complex Money Purchase Annual Allowance (MPAA) rules.

It restricts the amount of tax relief given on future pension contributions to stop pension ‘recycling’ where people essentially gain double tax relief. It limits the amount to just £4,000, including contributions paid by the worker, an employer and anyone else.

Stephen Lowe, group communications director at Just Group, said a £4,000 annual input limit is equal to a maximum employee contribution of £187 a month for a basic rate taxpayer whose employer is contributing £100 a month.

“This may sound a lot but is a relatively modest sum where people are trying to build up a pot quickly, which is typical for those in the last few years before retirement or if they have dipped into their pension to help them through a tough spot due to the pandemic or cost-of-living crisis.”

‘Rules apply for life’

Lowe added he was concerned many people may be taking flexible payments without fully understanding the complex rules that were introduced as part of the 2015 pension ‘freedom and choice’ reforms.

“Once triggered, the rules apply for life – you can’t go back – so it is important people understand the consequences,” he warned.

According to figures from regulator, the Financial Conduct Authority (FCA), less than half (47%) of the 700,000 pensions accessed each year are taken after professional financial advice or use of the government’s free, independent and impartial Pension Wise guidance.

“If people are thinking of making a pension withdrawal and wondering if they’ll become subject to MPAA rules, then the answer is that it depends,” Lowe said.

He said: “Taking tax-free cash doesn’t trigger the MPAA rules but any amount above this does. Buying guaranteed lifetime income isn’t a trigger but withdrawing funds designated to drawdown is. Full withdrawals may or may not trigger the MPAA depending on the size of the pot being taken. And the MPAA limits only apply to defined contribution saving, which means most private sector employees and self-employed pension savers will be at risk.”

Financial penalties for getting it wrong

Under the MPAA rules, there are also strict requirements to notify the saver’s other schemes that a flexible payment has been taken.

Lowe said: “It’s a veritable web of dos and don’ts, topped off by the fact there are financial penalties for getting it wrong.” This includes a fine of £300 plus £60 a day for failing to notify other schemes within 91 days that a first flexible payment has been taken.

He said that the complexity underlines the importance of boosting usage of Pension Wise guidance that has been shown to give people more confidence with their pension decisions and help them to avoid scams or paying extra tax.

“The government has said it wants taking guidance to become ‘the norm’ but currently it is not reaching enough people, suggesting a more robust intervention – such as auto-enrolling people into guidance sessions – is required,” he said.

“MPs on the Work & Pensions Select Committee recently reiterated their call for an evaluation trial to test the effect of auto-booking people into Pension Wise appointments. Hopefully, the new Pensions Minister will be more interested in finding solutions to this problem,” Lowe added.

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