November 30th, 2021
Are your clients at risk of falling into the “pension dipper” tax trap?
Since the government implemented Pension Freedoms in 2015, the change has allowed millions of people to access their pensions in a much more flexible way. While this has obvious benefits, it can also have unforeseen consequences.
If your clients aren’t able to make a properly informed decision, one of the potential pitfalls that they may run into is triggering the Money Purchase Annual Allowance (MPAA). According to figures published by PensionsAge, more than 1,000 people run into this issue each working day.
If you have clients who are approaching retirement, then it can be important to know how to avoid this potential tax charge. Read on for an explanation about how the MPAA works and how your clients can avoid falling into this tax trap.
The MPAA can reduce the tax relief that your clients receive
For many years, the traditional “cliff-edge” retirement was the default, whereby clients left work on Friday and woke up on Monday as a “retired” person. However, in recent years it has become much more popular to take a “phased approach” due to the benefits that this can bring.
For example, not only does it enable people to continue to see their old friends and colleagues, but it can also help them to build up pension wealth. This can give people more confidence that they’ll have enough to support their desired lifestyle throughout retirement.
However, the MPAA can pose a potential issue for clients who want to flexibly draw their pensions.
To put it simply, it reduces the amount of tax relief that a person can receive on their pension contributions if they’re flexibly drawing from it.
As you may know, clients can receive tax relief on any contributions up to a threshold called the Annual Allowance. In the 2021/22 tax year, this stands at £40,000 or 100% of a client’s earnings, whichever is lower. This includes the money clients pay in, as well as contributions made by their employer.
However, once a client begins to access their pension flexibly, the MPAA takes effect, and their Annual Allowance is reduced from £40,000 to just £4,000. This means that your clients will only be able to receive a much smaller amount of tax relief.
Of course, this restriction only applies to contributions that your clients make to a defined contribution pension. If they have a defined benefit pension, sometimes known as a final salary pension, then this rule doesn’t apply.
Triggering the MPAA could cost your clients a significant amount of tax relief
One of the obvious problems of triggering the MPAA is that your clients could lose a significant amount of valuable tax relief, which otherwise could have been used to fund their retirement.
As you may remember from our previous article on the subject, the amount of relief a client receives is dependent on what Income Tax band they are in.
For example, if they are a basic-rate taxpayer then the government will top up their contributions with an extra 20%. This means that to make a £100 contribution to their pension, a client would only actually need to put in £80.
As you might imagine, if your clients trigger the MPAA then a large portion of their contributions will no longer be tax-efficient. This could pose a potential issue as it may mean that they need to re-assess their retirement plans.
Working with an adviser can help your clients to make an informed decision
Retirement should be a time to relax and enjoy the rewards of a lifetime of hard work, which is why tax issues are the last thing your clients need if they’re approaching this period of their lives. Thankfully, this is where seeking professional advice can help them.
Working with a planner can help your clients to avoid some of the major tax pitfalls that they might have otherwise run into. This can give them greater peace of mind to know that there won’t be any unexpected issues in retirement.
A planner can also help your clients to assess their retirement plans to ensure that they’re growing their pension wealth in the most effective way. They can also help them to find a sustainable level of withdrawals, so your clients won’t have to experience any financial anxiety while they enjoy the rewards of their hard work.
Get in touch
If you have clients who are approaching retirement and may benefit from seeking professional advice, we can help. Email email@example.com or click here to request a callback from one of our advisers.
A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation, which are subject to change in the future.
This article is no substitute for financial advice and should not be treated as such. To determine the best course of action for your individual circumstances, please contact us.