Sting in the tail
Be wary about taking pension benefits if you are still paying into your retirement fund.
Three months on from the introduction of the new pensions regime it appears that many people have already taken advantage of their newfound freedoms.
Research conducted in the run-up to the changes suggested that 31% of those over the age of 55 were planning to access their pension as soon as the new rules allowed.¹ Chancellor George Osborne recently reported that 60,000 people had withdrawn over £1 billion from their retirement funds since the rules changed.
However, there is a possible sting in the tail for those who are taking pension benefits while still contributing to another pension scheme. For the unwary this could have a big impact on their future retirement plans.
As long as you have sufficient relevant UK earnings, you can invest £40,000 into your pension and get tax relief on the contributions; this is the annual allowance. This total includes all of your own and any of your employer’s contributions and applies across all of your pension schemes.
But if you do something that triggers a reduction in your annual allowance, it drops from £40,000 to £10,000. A number of different events can create this problem, including when you take your pension as a lump sum.
Ian Price, divisional director at St. James’s Place, says that for many people withdrawing money from their pension pot may well be the right decision, as long as they understand the implications of what they’re doing. But his concern is that not everybody does. “One of my big worries is that in their eagerness to take money out of their pensions, many savers in their mid to late fifties will unwittingly trigger a reduction in their annual allowance.
“For the majority of pension savers, this is the time when they’re contributing the most to their pension. A reduction in their annual allowance at what is often the optimum point in their earnings potential could thwart efforts to build the pension pot needed to last them through later life,” Price explains.
If you want to take money out of your pension, there are a number of ways you can do it without reducing your annual allowance.
One way is to buy a traditional annuity. You can take 25% of your pot as tax-free cash and use the rest to buy the annuity. You can then continue to make tax-efficient contributions up to the maximum annual allowance of £40,000 in future years, assuming you continue to maintain the earnings requirement. But if you buy a new-style short-term annuity, this will trigger the £10,000 annual allowance – so ensure you seek advice first.
Another option is to go into flexi-access drawdown and ensure you only take your 25% tax-free lump sum. So long as you don’t go on to take a retirement income, you won’t trigger the reduction in your annual allowance. This option offers access to your money and your annual allowance isn’t affected until you’re ready to take the remaining 75% as income. This option has the added advantage of enabling your residual fund to continue to grow.
A final option is to use the new small pots rule. This allows you to cash in a maximum of three money purchase pensions with an individual value of up to £10,000, although there is no limit on the number of some types of occupational pensions. The first 25% is tax-free and the remaining 75% is taxed at your marginal tax rate.
This rule gives you full flexibility to cash in some of your pension, perhaps to meet a short-term need, without affecting your future ability to maximise the £40,000 annual allowance.
In this liberated world for pensions, people have been given much better access to their money but, as Price stresses, “It’s vital that people seek advice to avoid stumbling into the unseen traps”.
The value of an investment with St. James’s Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested. The levels and bases of taxation, and reliefs from taxation, can change at any time. The value of any tax relief depends on individual circumstances.
1 Aegon Retirement Readiness Survey, May 2015