- The Government is facing calls to cap pensions tax-free cash and hike the minimum pension access age
- The Resolution Foundation says the measures are needed to encourage older workers to stay in the labour market for longer (Post-pandemic-participation.pdf (resolutionfoundation.org))
- Earlier this month, the Institute for Fiscal Studies backed restricting tax-free cash as part of a radical overhaul of pension tax rules (Restricting pension tax-free cash would be deeply unpopular | AJ Bell)
- Both reports ignore the most obvious pension tax penalty for over 55s returning to the workforce – the ‘money purchase annual allowance’
- AJ Bell warns further restricting tax-free cash risks being both “complex and ineffective”, while breaking the link between the minimum access age and life expectancy makes “little sense”
Tom Selby, head of retirement policy at AJ Bell, comments:
“Capping pension tax-free cash is all-too-often pushed as a solution to problems facing Government, whether that’s raising new money for the Exchequer or, in this case, tackling labour market shortages. However, further limiting pension tax-free cash risks being complex, ineffective and fundamentally undermining incentives to save for retirement.
“If pension tax-free cash were to be further restricted – it is of course already limited by the lifetime allowance – serious consideration would need to be given to managing the transition from the current system to a reformed system.
“The Resolution Foundation report makes no mention of this transition – or indeed the level at which the cap should sit – and yet it would be absolutely critical in determining the overall impact of the policy. It also doesn’t say anything about the potential consequences to retirement saving incentives that would flow from this policy.
“If the Chancellor used his March Budget to announce a tightening of pension tax-free cash restrictions, he would need to set out what would happen to existing entitlements. Millions of Brits have agreed to lock their money in pensions for decades in part because they were told they could get a quarter of their pot tax-free when they reach the minimum access age, which is currently set at 55.
“Any new limit on tax-free cash would, presumably, therefore need to ensure tax-free cash entitlements linked to contributions already paid in are protected. If this didn’t happen, then trust in retirement saving could be fatally undermined. As a result, we would move to a complex two-tier system, with any impact on the labour market and Government finances unlikely to be realised for decades.
“Furthermore, one of the few things most people genuinely understand and value about pensions would have been diminished, creating the risk of more people either cutting back contributions or simply deciding retirement saving isn’t worthwhile. That would be a disaster not just for current policymakers, but for future Governments (and taxpayers) who would eventually end up picking up the bill.”
Increasing the minimum access age
“The Resolution Foundation also wants to hike the minimum age at which people can access their retirement pot. This ‘normal minimum pension age’ is due to rise to age 57 by 2028, with a 10-year gap to the state pension age expected to be maintained beyond that.
“While there is no ‘right’ answer for setting the minimum access age, the current approach at least maintains a link with life expectancy. It also gives people flexibility to access their pension to suit their needs and personal circumstances. Randomly increasing the NMPA beyond 57 makes little sense.
“It’s also worth noting that the Treasury made an absolute Horlicks of increasing the minimum access age from 55 to 57, creating complicated protection regime for those whose scheme rules give them an ‘unqualified right’ to an NMPA of 55. If this sets the precedent, then any move to hike the minimum access age again would inevitably bring forward further complexity.”
Addressing the pension tax penalty for older workers
“If the object of the exercise is encouraging more older people into the labour market, addressing the retirement saving penalty imposed on those who have flexibly access taxable income from their pot feels like a no-brainer. It is therefore surprising the Resolution Foundation made no mention of this in their report.
“As things stand, anyone who flexibly accesses their pension from age 55 triggers the ‘money purchase annual allowance’ (MPAA), reducing the maximum amount they can contribute and receive tax relief each year from £40,000 to just £4,000. Those caught by the MPAA also lose the ability to carry forward unused annual allowances from the three previous tax years.
“The Treasury itself admits around 25% of pension savers aged 55 and over contributed above the MPAA in 2020/21. This, combined with the fact many will be forced to turn to their pension in the coming months and years to cover higher living costs, points to a real risk of mass breaches of the MPAA.
“Keeping this roadblock to saving for retirement in place runs directly counter to stated Government policy. The Government is desperately trying to get older people back into the workforce, yet by setting such a low MPAA it is creating a disincentive by limiting their ability to build or rebuild their pension.
“As a minimum, the Chancellor should increase the MPAA to £10,000, the level it was originally established at. However, over the medium-term the Treasury should consider whether the MPAA is necessary at all.”
How can people access their pension without triggering the MPAA?
- Just take your tax-free cash. While accessing taxable income flexibly from your pension will trigger the MPAA, withdrawing your tax-free cash won’t. It is possible to ‘partially crystallise’ your fund so you just take out the tax-free cash you need, with the rest left in your fund and able to grow tax-efficiently.
- Take a small pot withdrawal. If your fund is worth £10,000 or less you can withdraw both the tax-free and taxable element flexibly without triggering the MPAA. You must extinguish the entire fund in order not to trigger the MPAA. You can take up to three small pot withdrawals worth £10,000 or less in your lifetime from personal pensions, and unlimited small pot withdrawals from workplace pensions.
- Capped drawdown. Capped drawdown is no longer available, but some savers who were in capped drawdown before April 2015 have remained in it. Provided any withdrawals taken via capped drawdown do not exceed the maximum income limit (150% of the GAD annuity rate), the MPAA will not be triggered.
