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 accidentally trigger a reduction in their Annual Allowance.
So long as you have enough relevant UK earnings, you can put £40,000 into your pension and get tax relief; this is the Annual Allowance. This total includes all of your own and any of your employer’s contributions and sits across all of your pension schemes.
This is worth remembering as more flexible working patterns mean you might have built up numerous pensions and you may be still be contributing to a pension while also receiving a pension income. Or if you get a new job, you’re likely to be auto enrolled into your employer’s workplace pension scheme and start making contributions.
But if you do something that triggers a reduction in your Annual Allowance, it drops from £40,000 to £10,000. And this may affect your future retirement plans.
Media and industry comment has all pointed to the number of people who may take money out of their pension as soon as the rules allow. Our own research conducted recently found that 31% of over 55s were planning to access their pension after 6 April, when the new flexibilities came into place.
There’s nothing wrong with this so long as it’s the right decision for your individual circumstances and you understand the implications of what you’re doing. But unfortunately I don’t think everybody does.
For the majority of pension savers in their mid-to-late fifties, this is the time when they’re contributing the most to their pension. But if you accidentally trigger a reduction in your Annual Allowance, it could scupper your efforts to build the pension pot you need to last you through your later life.
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, so let’s focus on these.
The first is buying a traditional, inflexible annuity. You can take 25% of your pot as tax-free cash and use the remainder to buy the annuity. You can then continue to make tax-efficient contributions up to the maximum Annual Allowance of £40,000 in the years ahead. But if you buy a new-style flexible annuity, this will trigger the £10,000 Annual Allowance – so always read the label.
The second is to go into income drawdown and 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 start taking the other 75% as income. You also get the additional flexibility of being able to continue to grow your unused fund.
The third option is to use the new small pots rule that allows you to cash in pensions with an individual value of up to £10,000 – a lifetime limit of three applies to contract based schemes, such as personal pensions, although there is no limit on some types of occupational pensions.
Just like other pension tax rules, 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 an immediate call on your finances, without affecting your future ability to make tax relievable savings up to the £40,000 Annual Allowance.
In this new world of pension freedoms the Government has ultimately given you better access to your money. The trick is to avoid stumbling into the unseen snakepits that this freedom creates.
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