Pension income is a crucial part of retirement and people spend their entire working lives building up their pots. Recent pension freedom rules allow people who are 55 or over to flexibly tap into their pension savings in a variety of ways.
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Because of this, some people in the current environment may withdraw funds from their pensions to cover emergency coronavirus themed problems.
An understandable choice but one which may bring with it problems on its own.
LEBC, the financial advisory organisation, warns that pension withdrawals may trigger a little known reaction which could cost retirees dearly.
There are “Money Purchase Annual Allowance” (MPAA) rules in place which will restrict future tax relieved pension savings to no more than £4,000 a year once a pension pot has been flexibly accessed and any amount over the 25 percent tax free cash amount is withdrawn.
Kay Ingram, the Director of Public Policy at LEBC, commented on how this element of pension withdrawals is poorly understood: “This restriction is little understood by the majority of savers and comes as a nasty shock to those who thought they could withdraw funds from their pension for short-term needs and rebuild their savings
She went on to explain why this rule exists in the first place: “This rule was designed to prevent savers from taking advantage of Pension Freedoms introduced from 2015, by taking money out of their pensions and recycling it back in to claim a second slice of tax relief on the same money at a later date.”
LEBC explained that the MPAA was originally set at £10,000 and currently any savings made above a £4,000 limit, including employer contributions, are taxed at the savers’ income tax rate, cancelling out the benefit of tax relief on that element of their pension savings.
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Once the allowance is triggered, the saver also loses the right to carry forward any pension savings relief not used in the three earlier years, placing another barrier in the way of rebuilding retirement savings.
Complex rules mean that some withdrawals do not trigger this restriction, while others do.
There is, obviously, a big difference between £4,000 and £10,000 and Kay calls on the government to rectify this “obstacle” by focusing on this gap.
As she concluded: “It is wholly inappropriate for the government to place an obstacle of this nature in the way of prudent savers, needing temporary access to their pension savings.
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“A proportionate response would be to increase the MPAA limit on future pension savings back to £10,000 a year.
“Until that happens, those requiring flexible access to their pension savings should seek advice as it is in many circumstances possible to avoid the impact of this”
Advice can be sought from private companies and financial planners but it is also possible to receive impartial guidance from various public bodies.
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The Money Advice Service is one such example who has an entire page dedicated to MPAA.
They detail that MPAA won’t normally be triggered if a person:
- Takes a tax-free cash lump sum and buys a lifetime annuity that provides a guaranteed income for life that either stays level or increases
- Takes a tax-free cash lump sum and puts their pension pot into a flexi-access drawdown scheme but don’t take any income from it
- Cashes in small pension pots valued at less than £10,000.
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