Most people know they can draw the money in their pension pot from 55, and because they can – they do.
Very few sustainable drawdown plans are established by people in their fifties and very few annuities. 55% of annuities were taken out by people over 65. Only a few people under 65 swap their pension for an annuity and they shouldn’t have to worry for you!
The people who this article is for are the 72% of pension savers (around half a million of us) who access their plans for cash – not to pay themselves a wage in retirement. These are the people using “pension freedom” and generally they are “drawing down”.
When we look at what is actually meant by “drawdown” for those under 65 we find it looks rather like “fully withdrawing cash”, and very often all that is initially being withdrawn is the tax-free cash
Although the FCA data doesn’t tell us the proportion of people cashing in their pension plans at 55, they have this data elsewhere. The more detailed Retirement Outcomes review published in 2017 focussed on the behaviours of younger retirees.
Accessing pension pots early has become ‘the new norm’. Almost three quarters (72%) of pots that have been accessed are by consumers under 65. Most are choosing to take lump sums rather than a regular income. Over half (53%) of pots accessed have been fully withdrawn. However the fully withdrawn pots are mostly small with 90% below £30,000, and 94% of consumers making full withdrawals had other sources of retirement income in addition to the state pension.
This article looks at those people who have dipped into their pension and are at risk of making themselves “pension non-grata”, they are the people who carry on working after they’ve raided their pension savings pot and stay saving to SIPPs and workplace pensions.
Very few of us stop working at 55, but many of us risk wrecking our financial planning for want of properly understanding pension taxation. This article shows why.
We are looking at work and pensions the wrong way round
The key findings of the Turner report included the insight that we will need to work longer.
The people crystallising their pensions in their fifties, are not just cutting short the accumulation of savings in tax-priviledged, low-charging default investments, they are cutting off the oxygen line to future saving.
The Money Purchase Annual Allowance will prevent them ever again saving more than £4000 pa into a pension , without punitive taxation.
But our fifties and sixties are years when we generally stay in work, stay in workplace pensions and have high disposable income as liabilities for families decreased. Statistics from the ONS suggest falling levels of unemployment and economic inactivity for those in the 55- 75 age group.
These twenty years could well be the most economically active years of our lives but they are being lost to meaningful pension contributions by those who thought that taking some cash out of their pension in their mid fifties was ok – especially if it was tax-free cash.
That cash mayn’t be so “tax-free” after all
Let’s think of this from your point of view . You have the average pension pot of £40,000 and you’re having your 55th birthday.
You crystallise some money ( £10,000) out of your pension pot today . You’re told this doesn’t impact your take home pay and doesn’t create a tax-bill at the end of the year -(its your tax-free cash).
Oh- and you take a couple of thousand on top under flexi-access drawdown – you are told you will pay tax on that.
But you may not have been told that now you are “pension non-grata”. By taking that £2,000 (it would be the same if it was £2), you have triggered the money purchase annual allowance and that could be a nightmare to you, for the rest of your working life.
Let’s see how this works out as your case study
You are on £50,000 pa and you are in a pension scheme where 10% of your pay goes into a workplace pension. Because you’ve triggered the MPAA, you now have to tell payroll that you can only get tax-relief on the first £4000 of your contribution, the other £1000 gets no tax-relief and that any private savings you are making into pensions will also lose their tax relief.
To repeat; – the moment you paid yourself under flexi-access drawdown that £2000, you triggered the MPAA and “crystallised” your pension and a potential tax-nightmare.
Indeed, if you are saving privately it is your duty to stop or tell them to give you no tax relief. Failure to do so will incur a fine (90 days after crystallisation ) of £300 and a massive penalty of £60 a day for each further day of non payment.
And the impact of this restriction is not just for this year, you are going to be caught by this Money Purchase Annual Allowance, every year for the rest of your life.
Taking that £15,000 has effectively neutered your savings productivity for ever and cut you off from the oxygen not just of higher rate relief but any relief , for all but the first £4,000 you and your employer put in your pot each year.
And you weren’t thinking of retiring anyway!
You were told your pension was like a bank account, you had the freedom of having your money when you liked, but no one told you the rules – read the rules from the link at the end of this piece and you’ll see why – they are complicated;
You cannot run back to your pension provider with the £12,000 and say have it back, because £8,000 of that will be hurt by the MPAA and it won’t make a blind bit of difference to HMRC to whom you are “pension non grata“.
£50,000 pa isn’t that high an income for someone at the peak of their career and 10% isn’t that high a pension contribution. Imagine the impact on someone earning twice that with a “catch-up” pension contribution of £20,000 a year. Imagine the impact of taking money from your pension and finding that your contribution has been tax-restricted by 90%. The annual allowance shrinks when you take £10,000 or more out of your pot from £40,000 to £4,000.
For all the people who thought their retirement planning could be caught up in the last 10-20 years of their lives, crystallising your pension in your fifties makes you “pension non-grata”.
Yet another unworkable tax?
We are getting used to hearing about pension taxes causing problems , for everyone from highly paid doctors to people on minimum wage caught by the “net pay anomaly”
We don’t have statistics on the number of people who have been caught by the MPAA. Steve Webb tried to get them but was told by HMRC they had no idea of the amount of non-compliance.
Despite the real time information system being in place in large parts of the tax-system, pensions appear to be living in a digital stone age.
In response to Steve Webb’s freedom of information (FOI) request HMRC confessed that while it has access to information within the scope of the request, it ‘would exceed the FOI act cost limit’ to find out and it was therefore ‘not obliged’ to comply.
HMRC said it would breach the limit because it would need to extract all of the information and go through each individual case to identify an exact figure.
If this tax is working, we don’t know how and nor- it seems – do HMRC!
The new norm?
If , as the FCA observed in the Retirement Outcomes Review, “accessing pension pots early has become ‘the new norm’. then almost three quarters of us savers , have cut ourselves off from tax-incentives for future savings.
I know that many of us will not be thinking of saving £4000 per annum ourselves, but if we are in a workplace pension scheme, we have to include the employer’s contribution as well. That means that many of those 72% of people who have crystallised their pensions will be running foul of HMRC – that might even be you.
The “New Norm” may include the biggest pension tax mess yet, but then again it might not – who knows – it’s all so incredibly complicated.
If this is what you want from pensions , fine. You are probably a tax-expert, a financial adviser or both. But if you are reading this as a non-pension person, you may well be saying to yourself – if this is freedom, I’d rather be locked up!
What to do if you’re worried
If you want to read all the hideous detail, including your responsibilities to tell everyone what you’ve done, here are the rules courtesy of the Prudential’s tech team.
If you are lucky enough to have someone at work who looks after pensions, speak to them and ask whether you will have a problem going forward (or possibly with non-disclosure).
In any event, it is worth giving TPAS (part of the Money and Pensions Service) a ring, to make sure you are doing the right thing. You can get to them in working hours on