Most workers across the country only really start thinking about retirement when they are nearing it, largely due to the fact that making the decision to stop working can be daunting.
Understanding retirement can sometimes be the difference between having a secure financial future or taking a risk which can lead to financial repercussions. For many people with a private or workplace pension, knowing they can start to access their hard-earned savings from the age of 55, while still in employment, is a temptation hard to resist. However, some may not be aware that by doing so, they could affect how much they get when they do eventually retire.
Accessing your pension before retirement could trigger the Money Purchase Annual Allowance (MPAA), potentially reducing how much you can tax-efficiently save into a pension over the rest of your career. For most people, their pension becomes available at the age of 55, rising to 57 by 2028, even if they plan to work past this point. It means you can access your pension while still working, providing flexibility, however, thousands may be doing so unaware that it could affect their pension contributions in the future.
Retirement planning means pulling together a lot of different information and understanding regulations. When you access your pension for the first time, it’s important to have a plan in place. The decisions you make when deciding to access your pension could affect your income for the rest of your life, so a long-term outlook is essential. You also need to consider things like how you’ll access your pension, tax liability, and if you have multiple pensions, which ones to use first.
If you’re planning to access your pension before retirement, there’s a risk that you may be caught out by the Money Purchase Annual Allowance. Doing so unwittingly could limit how much you’re able to contribute to pensions in the future and reduce tax efficiency.
In most cases, you can contribute 100% of your annual earnings up to a maximum of £40,000 to your pension each tax year. You receive tax relief on these contributions at the highest level of Income Tax you pay – as a result, your pension receives an instant boost and makes saving for retirement efficient. If your ‘adjusted income’ – your annual income before tax plus the value of your own and any employer pension contributions – is more than £240,000 per tax year, your pension Annual Allowance may be reduced by £1 for every £2 that your adjusted income exceeds £240,000 under the Tapered Annual Allowance rules.
The MPAA reduces the amount you can tax-efficiently save into your pension each year. If triggered, your annual allowance would reduce to just £4,000. The rules around the MPAA are complex but the main situations where it will be triggered include, withdrawing your entire pension, putting your pension money into a Flexi-Access Drawdown scheme and starting to take a flexible income, or purchasing an Annuity. You can usually take a 25% tax-free lump sum from your pension without triggering the MPAA, depending on the rules of the pension scheme. However, it’s still important to fully understand the impact of this decision. Taking a large lump sum early in retirement, or even before you retire, can have a significant impact on the income your pension will deliver.
If you’re not sure what your pension allowance is, or would like some advice, please get in touch with your financial planner here.
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