And so it is for the proposed Money Purchase Annual Allowance (MPAA) reduction from £10,000 to £4,000 per annum. This is the lower annual allowance that applies once you’ve accessed pension savings flexibly.
Its aim is to minimise the potential for individuals to get a double dip of tax relief by cashing in pensions and then recycling the proceeds back into a new pension scheme.
Back in 2004, hip hop band The Streets released an album called A Grand Don’t Come For Free, but under the current pension freedom rules it does.
Consider a higher rate taxpayer who takes a first UFPLS (a cash lump sum from a pension) withdrawal of £10,000 from his pension. After tax he gets around £7,000 but in order to restore his pension savings of £10,000 he only needs to, in effect, put in a net £6,000 which will attract £4,000 of tax relief. Ta da! He’s just made a grand for filling in a few forms.
It might, therefore, seem reasonable for the government to seek to remove this loophole, but reducing the MPAA is the classic case of sledgehammer and nut. The policy is likely to impact a great number of people who are, and always have been, “doing the right thing”. It will also have a significant impact on employers operating good pension schemes.
Consider a workplace pension scheme where the employer pays 6% and the employee pays 4% of salary. The proposed reduction in the MPAA would mean that anybody earning over £40,000 who accesses a pension flexibly would find that they could not claim relief on all of their pension contributions.
In fact, the contributions could still be paid but the individual would be subject to a tax charge that they would have to meet from their own pocket. “Scheme pays”, which would take the charge automatically from funds in the pension, doesn’t apply for the Annual Allowance charge in this situation. So either the employee gets hit or the employer has to fiddle around with its benefit rules possibly limiting the pension contribution and offering an alternative benefit. We’ve seen this already with Tapered Annual Allowance and it’s not pretty.
We’re told that this isn’t a bad policy because only a few people (3%) pay more than £4,000 pa and the limit is well above what would be payable under automatic enrolment. That may be but isn’t the point that we’re trying to get people to save more? Industry consensus is that you need to save somewhere between 12% and 16% of salary to get a decent retirement income and that’s if you’re young. For those nearing retirement looking to catch up they may need significantly more.
We could just tell people who would be affected that they shouldn’t access their pensions flexibly, at least not until they’d finished saving. But that flies in the face of how retirement patterns are changing and how people are using pension freedom. The ability to draw down benefits from one pension arrangement while still accruing entitlement in another is very popular and allows retirement income to be tailored to meet the varying needs of the new retirement. Such a sharp reduction of the MPAA will reduce this flexibility for many who are still building up retirement assets.
So what is the answer? The existing tax-free cash recycling rules provide a good starting point but will require additional reporting to HMRC to be effective. These rules look at how contribution patterns change before and after pension benefits have been accessed. The challenge for HMRC is that while they should know when a pension has been accessed, they don’t always know what contributions are made by or on behalf of an individual. They do for personal pensions but not for trust-based plans. I must admit that I find this surprising. Surely given the cost of tax relief we’d expect our tax authorities to have greater visibility of who’s getting it.
The other challenge with this policy is that I suspect many out there have triggered the MPAA but have not told their current provider. While they are obliged to do so the reality is that some will have not done so, not because they are dodging tax but because they simply don’t understand the rules. HMRC having better information on contributions would allow them to ensure that the Annual Allowance rules are policed more effectively, ensuring less tax leakage and avoiding nasty surprises for individuals.
It feels like this is a more sensible approach for the long term than constraining those who are already saving at a decent level and want to take advantage of pension freedom. Even if we decide that reducing the MPAA is the only option, we should certainly consider whether such a sharp reduction is necessary and whether it’s realistic to introduce the policy with such short notice. I think you can guess where I stand on those questions.
You can find out more about the tax allowances using Fidelity factsheets: https://www.fidelity.co.uk/investor/pensions/pension-changes.page
Richard Parkin, Head of Pensions Policy, Fidelity International
Richard heads Fidelity leads Fidelity's retirement thought leadership combining with colleagues around the globe to provide fresh insight into the ever more complex issues customers face in saving for and living in retirement.
The value of investments and the income from them can go down as well as up, so you may not get back what you invest. Eligibility to invest into a pension and the value of tax savings depends on personal circumstances and all tax rules may change. You will not normally be able to access money invested in a pension till the age of 55. The Government’s Pension Wise service offers free, impartial guidance to help you understand your options at retirement. You can access the guidance online at www.pensionwise.gov.uk or over the telephone on 0800 138 3944. This information does not constitute investment advice and should not be used as the basis for any investment decision nor should it be treated as a recommendation for any investment. Investors should also note that the views expressed may no longer be current and may have already been acted upon by Fidelity. Fidelity Personal Investing does not give personal recommendations. If you are unsure about the suitability of an investment, you should speak to an authorised financial adviser.