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Lockdown pension dippers face tax trap

Ed Monk

Ed Monk - Fidelity International

Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

We’re still only beginning to learn the economic effects of the pandemic, but we already know that the costs have not fallen equally.

Those able to keep their jobs may be sitting on handsome savings made in the past year. If they had money invested in the stock market they could have enjoyed a positive year of returns as well, despite the sudden crash at the start of lockdown.

Many others, however, will have been left badly exposed as their earnings dried up, and may have been forced to raid savings to make ends meet. There was worrying evidence of this trend in news reports at the weekend which claimed as many as 260,000 people over age 55 had dipped into their pension during 2020.

Analysis of HM Revenue & Customs data by Just Group, cited in the Financial Times, showed 5,000 people a week withdrew taxable sums from their pension last year. By taking taxable money in this way, these people also triggered a dramatic reduction in the amounts they can pay into a pension in the future and still enjoy tax relief. 

It raises the risk that some of these people will have unknowingly restricted their future retirement savings in exchange for the short-term cash boost from their pension.

The reduction comes as a result of something called the Money Purchase Annual Allowance (MPAA). When activated, the MPAA replaces the normal Annual Allowance for pensions which limits contributions to Defined Contribution pensions to £40,000 a year, or the value of your earnings in that year if it is lower. Contributions above that level do not enjoy tax-relief.

The MPAA lowers this limit to just £4,000. It is triggered when a person makes a taxable withdrawal from their pension. That includes withdrawals made using Flexi-Access Drawdown, Uncrystallised Funds Pension Lump Sums and some instances of money used to buy an annuity.  It does not apply if you withdraw any of the 25% of your pension pot which is allowed to be withdrawn tax-free.

The full rules governing the MPAA can be found in this guide

A person in need of short-term funds, because their earnings have fallen for example, could view their pension as a useful safety net but the MPAA means that they need to seriously consider how to make those withdrawals. If they are still many years from retirement-proper they may still wish to work in the future and contribute to retirement savings, but the MPAA will severely limit what they can save with tax relief. They may even have to give-up employer contributions to their pension if these take them over the much lower MPAA.

There are ways to avoid the MPAA, even if you do need money from your pension. As mentioned, tax-free cash does not activate the MPAA. Additionally, the rules governing small pension pots of less than £10,000 allow these to be withdrawn without triggering the MPAA either.

It makes sense to get some professional help if you are weighing up decisions which involved using your pension money. The government’s Pension Wise service offers free, impartial guidance to help you understand your options at retirement. You can access the guidance online or call on 0800 138 3944.

Some will benefit for paid independent financial advice. Fidelity’s ‘ Planning for retirement’ page can provide both guidance and advice around your retirement options. If you are looking to access your pension for drawdown, guaranteed income (annuities) or tax-free cash.

Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Tax treatment depends on individual circumstances and all tax rules may change in the future. The minimum age you can normally access your pension savings is currently 55, and is due to rise to 57 on 6 April 2028, unless you have a lower protected pension age. It’s important to understand that pension transfers are a complex area and may not be suitable for everyone. Before going ahead with a pension transfer, we strongly recommend that you undertake a full comparison of the benefits, charges and features offered. To find out what else you should consider before transferring, please read our transfer factsheet. If you are in any doubt whether or not a pension transfer is suitable for your circumstances we strongly recommend that you seek advice from an authorised financial adviser. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to a Fidelity adviser or an authorised financial adviser of your choice.