David King, Wealth Management Consultant at MJR Wealth Management warns that almost a million people are at risk of punitive tax charges because they haven't understood complicated rules on pension savings and withdrawals, according to new figures released by HM Revenue & Customs (HMRC).
Since 2015, savers have been able to withdraw from their pension funds in various ways from the age of 55. Yet many people who take advantage of the pensions freedom to take income out of their pension plans don't realise that, in most cases, this severely restricts their ability to make further savings.
While most pension savers will get a £40,000 annual allowance for contributions, a lower cap (known as the Money Purchase Annual Allowance (MPAA)), applies to most of those who have started accessing their savings at age 55 or older. This reduced allowance, worth just £4,000 a year, was introduced to stop people withdrawing large sums from pensions in order simply to reinvest the money and claim new tax relief.
Since 2015, 980,000 people have made withdrawals that mean they are now subject to the MPAA, says HMRC. Anyone who subsequently breaches the £4,000 contribution allowance faces a tax bill at their highest rate of income tax on the excess. A higher-rate taxpayer making a £6,000 pension contribution, for example, would have to pay tax on the additional £2,000, prompting an immediate £800 bill.
In practice, many people making pension withdrawals after the age of 55 also continue contributing to their savings, often for perfectly valid financial-planning reasons. They may be moving into part-time work, for example, supplementing their income with cash from their pension, while still retaining membership of their current employer's scheme. Or they may be accessing their pension to make a one-off purchase – a holiday home, say. Others may simply be reorganising their pension-savings strategy.
The MPAA trap is complicated by the fact that not all withdrawals trigger the lower limit on contributions. It does not apply to savers cashing in small pension funds worth less than £10,000, for example, or those who exercise their right to take a tax-free cash lump sum out of their savings but don't withdraw any income from the fund.
The MPAA warning is just another example of how savers are potentially being caught out by the pension freedom reforms. While the changes have benefited many people, they have also added significant complexity to the system. Overall, a third of savers fail to take financial advice on how to manage their pension-fund cash later in life, according to the Financial Conduct Authority, the chief City regulator.
If you have concerns about the complexities of the MPAA in respect of your circumstances then please email David firstname.lastname@example.org