Change to the “money purchase annual allowance” means people must be far more certain that they are ready for retirement before accessing pensions, Aegon has said.
The change was made in last week’s Autumn Statement.
Kate Smith, head of pensions at Aegon, said: “The ‘money purchase annual allowance’ will be reduced from £10,000 to £4,000 a year next April. This means that once you start accessing money from a flexi-access pension, the maximum you will be able to continue paying into a pension and earning tax relief falls by £6,000.
“The money purchase allowance was introduced ahead of the pension freedoms to prevent people ‘recycling’ their pension saving which involves a process of taking money which has already received the benefit of government tax relief (20%, 40% or 45% depending on your tax band) and then adding it back to a pension and receiving the government top up again.
“If you are retiring in the traditional sense and giving up work completely to then live on your savings this change is unlikely to affect you. However, if you’re accessing your pension at an early age, from age 55 under the pensions freedoms, perhaps to pay off a debt, then the reduction could create a problem. Instead of being able to keep saving up to £40,000 a year into a pension tax free, the amount you can pay in will fall to just £4,000 and any contributions above this will be taxed at your marginal rate. As a result people need to be certain that they’re all set for retirement before accessing these savings or at least understand that it will affect their ability to keep saving into a pension.
“This rule highlights a general point about prioritising which savings you use up first in retirement as this can be almost as important as saving itself. Taking your savings in a particular order can make a big difference to how much tax you’ll pay and how much can be paid into your pension, making your savings last longer. It could also allow you to leave more money to your loved ones following your death. Typically you shouldn’t take money out of a tax advantaged savings plan until you actually need the income.
“If you are still in the workplace, you and your employer are likely to be paying into a pension, and if you’ve haven’t built up an adequate retirement income you may want to have the flexibility to increase your pension contributions. You should also avoid jumping up a tax band and paying more tax than you have to. Being savvy can save you money.”