Part 3 – Approaching Retirement
This post is the third in our ‘pension pitfalls’ mini-series. The series is intended to highlight some of those areas which we feel can catch individuals out when it comes to their pension planning, or could mean that the tax advantages of the pension aren’t being fully utilised.
When income is drawn flexibly from a pension, this triggers the Money Purchase Annual Allowance (MPAA). This reduces the amount that can be contributed to a pension to just £4,000 per tax year (including both personal and employer contributions). Any contributions in excess of this limit would be taxed at an individual’s marginal income tax rate (20%/40%/45%).
With increased pension flexibility and income-drawing options for plans, individuals may look to use some of their pension capital whilst still working and accruing pension contributions on a month-by-month basis (say through the workplace pension offered by their employer). By way of example, an individual earning over £50,000 of salary with 8% pension contributions (4% employer, 4% personal), total pension contributions would exceed £4,000 per tax year.
When not taking advice, it can be quite tricky to navigate the world of pension legislation and we do come across individuals who have triggered the MPAA without being aware of this, and as a result have since contributed in excess of this allowance to their pensions. Some of the main situations where the MPAA could be triggered are:
When it comes to drawing income from pensions, there are a number of ways in which this can be actioned. In broad terms, these ways are split into two separate categories:
There is no ‘one size fits all’, and when it comes to the most suitable option for an individual then consideration must be given to personal circumstances, objectives, wider wealth and attitude to risk (to name just a few things!). Purchasing an annuity would give comfort and security over the level of income which will be paid during retirement, but there would be no flexibility to amend this, whereas drawdown offers the flexibility to amend the income level drawn but carries the risk of managing a fund to last for your full retirement (adviser input certainly needed!). For many, a hybrid set up combining both elements will likely be a strong solution.
It is important to be aware than some pension plans may not offer all of the flexible income drawing options, and it may be necessary to move your fund to an alternative contract if this is deemed to be appropriate. As you approach the retirement age of your pension plan, the plan provider will provide details of those options available within the existing contract – it is not a given that those are the only options available to the policyholder, but more that those are the only options available within the existing plan. Many newer-style pension contracts offer the full suite of options.
We understand that for many people, consolidating all of your pension pots to one place ahead of retirement can be very attractive. Whilst the majority of schemes will offer a transfer-out for this purpose, it is important that full details of the scheme have been read and understood as there may be some valuable benefits hiding within the scheme rules that could be lost on a transfer.
Some of the guarantees or benefits we see are:
If you do have a pension with one of these guarantees attached, it would be crucial to take advice in order to fully understand how this guarantee ties in with your own planning and circumstances, the trade-offs involved with transferring and whether the plan should be retained.
A number of individuals will hold a form of pension protection (e.g. Fixed Protection, Individual Protection, Enhanced Protection) in respect of their lifetime allowance – this is to total value of pensions that can be held without HMRC levying a tax charge.
The protections are extremely valuable, and each has its own criteria attached in terms of actions that may result in the protection being lost. For example, if a form of Fixed Protection is held (either 2012, 2014 or 2016) then no further pension accrual can occur (except in limited circumstances) whereas Individual Protections allow you to continue accruing benefits. There are also rules around the types of transfers which can be actioned by someone holding protection. If protection is lost, it is the pension member’s responsibility to report this to HMRC (in writing) – HMRC will levy monetary penalties if this reporting is more than 90 days after the event.
We see cases (thankfully not too frequently) where individuals hold a form of pension protection and have invalidated this without realising – for example by being auto-enrolled into a workplace pension scheme whilst holding Fixed Protection, or by actioning an unauthorised transfer (e.g. where an enhanced transfer value has been offered).
Whilst working, entitlement to the UK State Pension is accrued through National Insurance Contributions (NICs). In order to be eligible for the full level of pension (£179.60 gross pw in 2021/22), 35 ‘qualifying years’ are needed. We see State Pension often being overlooked by individuals however this provides a secure source of guaranteed income that can underpin your retirement position.
‘Qualifying years’ can be accrued by those working (both employed and self-employed), but credits are also given for those who claim Child Benefit, get Jobseeker’s Allowance, Employment and Support Allowance or Carer’s Allowance. If there are gaps in your NI record which means that a full qualifying year hasn’t been achieved, there is the ability to pay voluntary NICs. These can generally be done for the past 6 years (hence the importance to stay on top of your entitlement), but there is currently an additional period available for those born after 5th April 1951 (men) or 5th April 1953 (women) whereby gaps between April 2006 and April 2016 can be filled – the deadline for this ends in April 2023. Of course, the ability to pay voluntary contributions (by way of lump sums) will depend on affordability, but on a purely financial basis we tend to find that these payments represent very good value for money
We often find that many individuals are not aware of their state pension entitlement, and therefore haven’t looked into whether they should be looking to ‘top-up’ any missing years. State pension forecasts can be obtained here: Check your State Pension forecast – GOV.UK (www.gov.uk), and this will show not only the current accrual (in £’s terms) but also how many additional years are required to achieve the maximum accrual.
The information featured in this article is for your general information and use only and is not intended to address your particular requirements. Whilst knowledge is power, the best way to naturally avoid any of these pitfalls is to take financial advice along the way from a pension specialist. Five Wealth Ltd offer independent financial advice to a wide variety of clients, at various stages throughout their investment and retirement planning journey. If you feel that our expertise would be beneficial to you, please get in touch.
The information contained within the article is based upon our understanding of HMRC legislation and practice. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts and their value depends on the individual circumstances of the investor.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). Your capital is at risk. The value of your investment (and any income from them) can go down as well as up and you may not get back the full amount you invested.
Workplace pensions are regulated by The Pensions Regulator.
Please keep an eye on our blog posts/linked where parts 1 and 2 of this ‘pension pitfall mini-series’ have been published, specifically focusing on considerations for pre-retirement and those approaching retirement.