In 2015 Pension Freedoms made pensions far more accessible and flexible for retirees. However, some accessing their pension early could find they’re affected by a cap that will restrict tax relief on pensions.
Under the regulation changes, pensions are now usually accessible from the age of 55. From this point, it’s up to the pension holder how and when they make withdrawals. Whilst initial fears that retirees would withdraw too much too soon have so far been unfounded, many people are taking advantage of being able to access their pensions before State Pension age. It’s a step that should be carefully weighed up with a long-term view in mind, but it can allow you to build a retirement that suits you.
Accessing your pension before traditional retirement
It’s a growing trend for workers to begin accessing their pensions, sometimes long before they plan to fully retire. There are many individual reasons why employees may be deciding to do this, from moving to part-time work to boosting their income to allow for more freedom.
In fact, research from Zurich found:
- 50% of people taking a regular income from a pension in drawdown are still in full or part-time work
- This is despite 55% of these full-time workers and 29% of part-time workers admitting they could live comfortably without the extra pension cash
This trend has led to fears that pension savers could burn through their cash too quickly. But it also raises another issue and may mean that future pension contributions aren’t as efficient due to the Money Purchase Annual Allowance (MPAA), which could affect retirement income.
What is the MPAA?
The MPAA reduces the amount of pension contribution that can benefit from tax relief.
Usually, you can receive tax relief on pension contributions up to £40,000 a year or 100% of your taxable salary, whichever is lower. However, if your taxable income is more than £150,000, your annual allowance will be reduced due to the tapered allowance. If this is the case, your annual allowance is reduced by £1 for every £2 over the £150,000 threshold, with a minimum annual allowance of £10,000.
The MPAA, which was brought in to coincide with Pension Freedoms, reduces what you can tax-efficiently pay into a pension once you’ve begun making withdrawals to £4,000 annually. The MPAA is designed to ensure savers are not recycling their cash through their pension in order to benefit from tax relief. Exceeding the MPAA could mean you’re left with an unexpected tax bill. However, it may also have a significant impact on financial and retirement plans.
The impact on your retirement plans
There have been some calls to increase the MPAA from the current £4,000 to £10,000. This includes pension provider Aegon, which says savers could too easily be caught out by the limit when accessing pensions. According to analysis:
- An individual earning £30,000 who, alongside their employer, are contributing sums equivalent to 14% of their salary to a money purchase would be caught out by the MPAA
- High earners may be caught out even if they’re contributing at far lower rates. Someone earning £30,000 with a shared employer and employee contribution rate of just 8% would exceed the MPAA
As a result, if you continue paying into a pension after you start making withdrawals, you could find that you unwittingly exceed the MPAA. In addition to potentially paying more tax, it may limit what you put back in. If you expected to continue making significant contributions until you’re ready to fully retire it could mean your pension fails to meet expectations.
It’s important that you take the MPAA into consideration, not only to assess your potential tax liability, but also the long-term impact on your pension savings. Even reducing contributions by a relatively small amount over several years can have a large impact once you factor in tax relief and investment returns.
The MPAA and what it means for retirement plans is set to become a growing issue. The Pension Freedoms and changing retirement lifestyles means that more people than ever before are choosing a phased retirement, blending work with increased free time. Therefore, it’s likely the number of people simultaneously contributing to a pension whilst making withdrawals will rise.
Financial advice and accessing your pension
Understanding how accessing your pension early will affect your finances now and in the future is crucial for making the right decision for you. In some cases, taking an income from a pension whilst still employed can be a valuable way to boost retirement income without it affecting your long-term aspirations. However, in others, it could mean needing to scale back retirement plans and there may be alternative options that are better suited.
If you’re unsure how accessing your pension sooner could have an effect, please get in touch. Effective financial planning can help you get to grips with how your pension and other assets will change over time depending on the decision you make.
Please note: A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. The tax implications of pension withdrawals, levels of and reliefs from taxation will be based on your individual circumstances. Tax legislation and regulation are subject to change in the future.