A hefty cut in the amount you can pay into a pension after you have started drawing income from it is due to come into effect on 6 April, and is likely to leave thousands of savers worse off. Cutting the money-purchase annual allowance (MPAA) from £10,000 to £4,000 will prevent people who have flexibly accessed their pension pot from recycling this cash into defined-contribution (DC) pensions, and getting a double helping of tax relief.
At present you are able to make tax-free contributions to a pension scheme of up to £40,000 a year, depending on your income. However, once a person aged over 55 accesses their pension via drawdown or a taxable lump sum, the amount they can subsequently contribute to a pension is limited to the MPAA of £10,000. The new rules will reduce this to just £4,000 for money purchase schemes, and if you exceed this amount the excess will be subject to tax at your marginal rate.
You will trigger the MPAA if you have previously accessed or access your DC pension pot after 6 April, in the following ways.
■ Flexi-access drawdown. Also known as income drawdown, this gives you the option to take 25 per cent of your pension pot tax-free and move the rest into investment funds, which will pay out a regular taxable income.
■ A flexible lifetime annuity. This type of annuity allows the income you receive to increase or decrease over time, but there are very few providers on the market.
■ One-off cash payment. This is known as an uncrystallised funds pension lump sum (UFPLS) and allows you to take ad hoc cash sums without needing to take any regular income. For each withdrawal the first 25 per cent will be tax-free and the rest will be taxed at your normal tax rate.
Crucially, the new MPAA will apply to anybody taking regular taxable income through income drawdown. But it won't apply if you just take the 25 per cent tax-free sum associated with drawdown. However, anybody taking a UFPLS will be caught by the rules.
Wealth advisers and pension providers have called for the cut in the MPAA to be scrapped. "The proposals create a cliff-edge where someone taking a tax-free lump sum can continue to save £40,000 per tax year, but anyone who receives a taxable income under the pension freedoms sees their annual allowance drop 90 per cent to £4,000," says Tom Selby, senior analyst at AJ Bell. "It does not make any sense that someone who chooses an option where they pay tax on their withdrawal is punished hugely in comparison to the individual who chooses the tax-free option."
Jon Greer, pensions expert at Old Mutual Wealth, believes the evidence that individuals are using the freedoms to recycle their pension pots is weak.
"In HM Treasury's consultation document, the government estimated that only 3 per cent of over 55s are likely to pay more than £4,000 next tax year," he says. "However, a Freedom of Information request from Old Mutual Wealth reveals that the government is not able to identify the number of individuals both accessing and saving into their pension, so the government's assessment of the impact of the MPAA is a best guess estimate."
The MPAA is particularly important for the increasing number of people who are working part-time post retirement age. Research from Old Mutual Wealth conducted with YouGov showed that a third of people surveyed are expecting a job to help fund their future retirement income.
Mr Greer says: "Many people choose to work reduced hours while topping up their pay by withdrawing some money from their pension. This flexible combination of salary and savings income is possible thanks to pension freedom reforms. But the MPAA curbs this flexibility by capping the opportunity to work, save and withdraw pension income in a fluid manner without the possibility of incurring some form of penalty."
Nathan Long, senior pensions analyst at Hargreaves Lansdown, is concerned the popularity of UFPLS suggests many thousands of people are likely to be affected by the changes. UFPLS was introduced in April 2015 to increase flexibility for retirees. Data from the Association of British Insurers suggests 300,000 cash withdrawals have been made using UFPLS in the first 12 months of availability, with 64 per cent of all retirements making use of it.
"Data of retirements of [our clients] shows 41 per cent of those accessing UFPLS, and therefore triggering the lower MPAA, are under age 60," Mr Long says. "The majority of these people will still be working. That means they've got another 10 years or so where their ability to pay any more money into their pots is limited."
Employer contributions also count towards the reduced MPAA, which means employees who have flexibly accessed their pot but are still contributing to workplace pension schemes could find their employers' contribution tips them over the allowance.
Mr Long explains: "Assuming membership of a workplace pension requires contributions of 10 per cent, a £4,000 MPAA catches anyone earning over £40,000 whereas currently it applies for anyone earning over £100,000."
Individuals who have previously drawn income flexibly from their pension pot, with the expectation that they could contribute up to £10,000 to a pension this tax year, will also be affected.
There are a number of reasons why people may want to access their pot flexibly, including being made redundant or needing to access the funds to clear debt, finance a divorce or manage a family emergency.
"These people have no intention of abusing the system," says Rachel Vahey, product technical manager at investment platform Nucleus. "Instead, they just want to access their own money - as promised by the government. Although cutting the MPAA will stop some who want to recycle pension benefits from doing so, the risk is that it disrupts many others' pension planning through collateral damage."
Many self-employed people and small business owners who use their pension pots to provide a stable, regular income to help smooth peaks and troughs of income are also likely to be affected, adds Greg Kingston, head of product and insight at pensions provider Suffolk Life.
But there are a number of things you can do to mitigate the cut in the MPAA.
1. Draw income from non-pension assets
Ensure you have savings outside your pension so that you are not forced to draw on it in an emergency. A good rule of thumb is to have six months of expenditure in cash to ward off unforeseen circumstances.
Individual savings accounts (Isas) offer flexible access, so you can save into one and withdraw income without constraints. You will be able to save £20,000 a year in an Isa from April 2017, up from the current allowance of £15,240.
2. Take a small pots lump sum
You have the option of taking up to three small pots of £10,000 from personal pensions over your lifetime. But the lump sum has to represent the entire pension pot. The first 25 per cent of the lump sum will be free of tax. The rest will be added to your individual income and be subject to income tax.
3. Manage how you draw income from a pension
A simple way to make sure you don't fall foul of the MPAA is to avoid drawing an income from your pension. Accessing your pension without drawing an income is possible, by simply drawing the tax-free lump sum only. This is possible using income drawdown, but not UFPLS.
Another way to manage how you take your income to avoid MPAA is through partial drawdown. This involves splitting your pension into parts and converting each part to income drawdown at different times, as and when you need the income.
David Brooks, technical director of pensions consultancy Broadstone, explains: "If you have a fund of £100,000 and you want £10,000 in cash, you can designate £40,000 in drawdown policy, take the £10,000 as tax-free cash, and take no income from the £30,000 but it will still be in the drawdown pot." And you still have the other £60,000 sitting in the pension pot - from which you can take a second tax free lump sum of up to 25 per cent without triggering the MPAA.
4. Talk to your employer about pension contributions
Your employer may be to offer flexibility on how much and where they pay contributions to your pension.
"The MPAA changes will affect employees of good companies operating good pension schemes," says Richard Parkin, head of pensions policy at Fidelity International. "At £10,000 this is not much of an issue, but at £4,000 many more will be affected."
It is also important to find out whether your employer scheme offers income drawdown.
"Many workplace pensions do not offer the ability to take just tax-free cash and no income," says Mr Long. "Move your pensions to a provider that can offer full flexibility to allow you to cope with your changing circumstances."
