REBA’s inside track: alerting employees to the pension tripwires

Former US president Benjamin Franklin’s famous quote that nothing in life can be said to be certain except death and taxes has felt more appropriate than ever over the last two years.

You can always rely on pensions to break the rules. Neither death (or at least the age at which we’ll die and therefore how long money has to last), or (pension) taxes are at all certain.

Arguments over the Lifetime Allowance (LTA), the amount of money you can pay tax-free into your pension over your lifetime, and the Annual Allowance (AA), the amount of money you can pay into your pension tax-free in a single year rightly rage before every Budget. They are confusing and potentially damaging to higher earners’ ability to save for retirement.

Much less focus is given to pension taxes and rules that affect members after they have started to access their pension. But these can significantly affect employees’ savings and how they manage their funds in retirement.

The pandemic has made many older employees question whether they want to remain in the workplace. Figures from WEALTH at work showed that around 22% of employees have brought forward their retirement plans. Some will also have accessed their pension pot to help them through a period of hardship. And many more people of all ages will have questioned their relationship with work and how long they intend to stay in traditional employment.

However, for employees who choose to access their pensions in their mid-50s – either now or in the future – there are potential tripwires in the pensions system that could affect their finances and impact their retirement long-term.

Make employees aware of the Money Purchase Annual Allowance (MPAA)

The snappily-titled MPAA is the amount of money that you can save tax-free into a pension each year once you have started to access your pension savings, and it is set at the pitifully low level of £4,000 a year. For comparison, the full AA is £40,000.

Employees who have opted to access their pension savings for hardship reasons or to reduce their working hours especially during lockdown, may now be constrained by the MPAA when saving for retirement in the future. It’s difficult to know how widespread this problem is because HMRC doesn’t currently collect data on MPAA breaches.

Freeze the age when employees can access their pension

We’ve become accustomed to being able to access defined contribution pension savings at age 55, but last year the government announced that this will increase to 57 from 2028. If employees who will reach their mid-50s in 2028 want to freeze their age of access at 55, they can do so – but only until April 2023. There is also an odd loophole in the legislation – if your pension scheme specifically allows access at 55 (rather than ‘at the minimum withdrawal age’), employees can still continue to access funds at that age. That differentiation will be scheme-specific, so check with your provider and make sure employees are aware of how this affects them.

Check the small print when consolidating pensions

Employees need a regular income stream in retirement. But with multiple pension pots, held with different providers, and with different access rules attached to them, creating that income stream is not always straightforward. Consolidating multiple pensions into a single ‘pot’ at retirement is one way of doing this, but every pension is different. There can be myriad small details (even within apparently run-of-the-mill DC schemes) which will make a big difference. These could include minimum age of access, add-on benefits such as with-profits, and in some instances other associated perks related to a specific employer.

Top up tax-free advice

Another lesser known tax-related element of pensions is the Pensions Advice Allowance. This enables pension scheme members to withdraw £500 tax-free from their pension three times during their working life to pay for financial advice. It is limited – it can only be used to pay for pensions-specific advice rather than wider financial wellbeing, and sadly £500 won’t go far in the advice market. But, if employers are prepared to top it up or offer subsidised advice to employees, this is a useful way of getting tax-free help to employees.

The government’s Pension Wise service is another, free source of guidance for employees over 50 years old – encouraging employees to access Pension Wise in the first instance and then use £500 to supplement that help could be a good starting point.

Talk to your pension provider about their tax support options

Different providers will have slightly different rules around how scheme members can use their savings. While there are well-known options, such as taking a 25% cash lump sum, there are also more complex options around how funds are used in drawdown that can make a significant difference to how employees pay tax after they retire, such as crystallising pension lump sums in order to reduce tax annually. The details are far from straightforward, but could make a significant difference over the course of an employees’ retirement.

The complexity of pensions and retirement options place many potential tripwires in front of unsuspecting employees. Supporting them through financial education, guidance or access to regulated advice can help to ensure they don’t get caught out.

The author is Maggie Williams, content director at REBA.