Proposed changes to Britain’s pension system may make life more challenging for older Britons, many of whom already face financial difficulties. New restrictions on pension freedoms are set to make the system less flexible. Will these restrictions affect you, and what can you do to minimise damages to your financial well being?
A dramatic cut to money purchase annual allowance
Pension freedoms launched in April 2015 granted savers the ability to access their pension savings flexibly according to their needs. Once they accessed their pension savings flexibly, if they wanted to make any further contributions to a defined contribution (DC) pension, their tax-relieved contributions were restricted to a special money purchase annual allowance, or MPAA. Now the cap on MPAA is to be dramatically reduced.
Amongst many other points in Chancellor Philip Hammond’s much-anticipated (or dreaded) Autumn Statement on 23 November 2016 was the announcement about a cut in MPAA, beginning in April 2017, from its current level of £10,000 to £4,000. The cut will apply for people who are utilising a flexi-access drawdown, or other income withdrawals such as a short-term annuity, and wish to continue making payments back into a DC pension.
The Treasury says that the reason for cutting the MPAA is that it wants to put the reins on people who are recycling money for tax relief purposes. The reasoning is that some people are receiving unfair advantage by accessing their pension funds and then recycling up to £10,000 a year into a new pension with tax relief. Treasury estimates are that the reduction in MPAA will generate an additional £70 million in tax receipts in the 2017-18 tax year, increasing to £75 million per year from 2020-21.
What this means to savers is that anyone who draws cash from their schemes – apart from the initial 25 percent tax-free lump sum – will have to be extra careful with future retirement savings plans. The proposed change is most likely to adversely affect people who are still working after withdrawing cash from their pension pots, for they could miss out on future valuable employee contributions on money put into pensions.
Critics are saying the cut will make the system far less flexible, flying in the face of the entire concept of “pension freedoms”. Chris Noon, a partner at independent actuarial consultancy Hymans Robertson, warned that many people may either be deterred from withdrawing from their pension or they’ll stop saving into it. He says the cut in the MPAA is “antithetical to the philosophy of pension freedoms, as well as unsupportive of flexible working.”
Steve Webb, policy director at mutual life insurance and pensions firm Royal London, said that the decrease will have a profound impact on people’s ability to go on working and contributing worthwhile amounts to a pension. He added, “We should be trying to make combining work and drawing a pension easier, not harder.”
And retirement advisory group LEBC has warned that further reductions in annual retirement savings allowances could create hardship to a minority of consumers who are already facing difficult financial circumstances.
Careful planning can minimise problems
Whether and how the changes to the pension system will affect you will depend upon your age, your retirement plans, the type of pension scheme you have, and other variables. But don’t try to figure everything out on your own. When making decisions about retirement strategies or any other important money matters, it is always a good idea to consult with a qualified financial advisor. Planning ahead is crucial, and a financial advisor can guide you through the maze.
It may be that you won’t even be affected by the changes. For instance, only certain types of pension withdrawal, such as flexi-access drawdown payments, will trigger the annual allowance reduction to £4,000. Uncrystallised funds lump sum payments and flexible lifetime annuities will also trigger the MPAA cap.
But taking tax free cash will not trigger the £4,000 MPAA, nor will anyone already in drawdown before 6 April 2015 see their annual allowance reduced – provided, that is, that they remain within capped drawdown limits. Payments of up to £10,000 paid out under “small pots” rules won’t trigger a reduction either.
If you’re anticipating a more traditional “clean break” from work, followed by straightforward income replacement from pension withdrawals, you probably don’t have to worry. The fact is, however, that retirement patterns are changing and many people are opting to reduce their hours in their later working years, topping-up their income via withdrawals from a pension. As indicated above, these are the people who may be adversely affected by the MPAA cut.
A good financial advisor can help you decide whether and how your pension assets can be obtained in a way that avoids triggering the reduction unnecessarily. Your advisor can also help you find other more tax-efficient ways of withdrawing money from other assets. Leaving pension savings untouched as much as possible is ideal, of course, but that isn’t always possible. Even so, careful planning can minimise problems and keep your pension pot as healthy as possible.
It’s never been more important to watch every pound
Age UK reports that one in seven pensioners, or approximately 1.6 million, are living in poverty, defined as having incomes of less than 60% of median income after housing costs. And an additional 1.2 million have incomes just above the poverty line – more than 60 percent but less than 70 percent of median income. Though the number has fallen substantially since the mid 1990s, progress has stalled and the numbers of impoverished pensioners has remained unchanged in recent years.
Living on a limited or fixed income isn’t easy for anyone, but in many ways it is much more difficult for older people than for those who are younger. No matter how dire your situation seems, however, you can still take steps to make it better, or at least avoid making it worse.
First off, don’t ever be afraid to seek advice and assistance, whether you need help with retirement strategies, budgeting, or figuring out the benefits to which you’re entitled (and you really should take advantage of every benefit due to you).
Secondly, if you find yourself in a cash crunch despite your careful planning, be aware that you have options even if you have credit problems. You may not be able to get a conventional loan from your bank, but there are other types of personal loan products that don’t require stellar credit. As long as you only borrow the amount you need, are certain that you’ll be able to pay the loan back on a timely basis, and you view the loan as a one-time, short-term solution and not an income source, you shouldn’t have any problems.
Finally, as we’ve said many times, keeping yourself informed is a crucial part of good money management. For starters, take some time if you haven’t already to read the Autumn Statement 2016 policy paper, which the Gov.UK site published on 23 November 2016. (Section 5.6 details changes in pension and savings policies.) And keep up with news and developments that affect your bottom line, working to improve your own financial literacy.