Helen Morrissey, pensions specialist at Royal London, says our pension tax system has become a tangled web that needs to be unwound.
The recent CPI inflation figures have provided a welcome boost of almost £18,000 to the Pension Lifetime Allowance.
So, assuming no further rounding up from the next tax year, pension savers will be able to accumulate a pension pot of £1,073,000 over the course of their lifetime before incurring a tax charge.
While this is good news, it also draws attention to how complicated the pensions tax system has become, with different elements operating at different speeds.
It is an extremely tangled web that needs to be unwound.
How does the annual allowance work?
In addition to the lifetime allowance, there’s the annual allowance, which puts a cap of £40,000 on the amount you can save into a pension every year and still receive tax relief.
But unlike the lifetime allowance, which rises in line with inflation every year, the annual allowance has remained frozen at £40,000 since the 2014/15 tax year.
It’s also worth noting both the lifetime and annual allowances used to be much higher.
As recently as the 2011/12 tax year, the lifetime allowance stood at £1.8m, while in 2010/11, the annual allowance was £255,000.
That was before the UK Government started whittling them down in a bid to save the amount of money it gave away in tax relief.
A complicated protection regime was brought in to protect those savers who already saved more than the new limits.
On top of this, a carry forward regime allowed people to make use of any annual allowance they may not have used over the previous three tax years.
These are issues that need to be monitored closely if tax bills are not to be incurred and financial advice is vital.
Money Purchase Annual Allowance
If all of that wasn’t complicated enough to wrap your head around, it doesn’t stop there.
Following a shake-up in how pensions can be accessed back in 2015, there were concerns that people would start pension recycling.
Essentially, pension recycling is where someone takes money from their pension and re-invests it back into the pension to claim extra tax relief.
To prevent this from happening, the Money Purchase Annual Allowance (MPAA) was introduced. This means that once you start taking money from a Money Purchase Pension, your annual allowance is cut from £40,000 to just £4,000 per year.
To further save on the amount of money the Government spends on tax relief, the tapered annual allowance was also introduced for those earning an adjusted income.
This includes all taxable income, not just earnings and employer pension contributions.
For every £2 earned over £150,000, the annual allowance is reduced by £1. This essentially caps someone’s annual allowance at £10,000 for those with an adjusted income of more than £210,000.
The resulting system is ridiculously complex and pretty much impossible to navigate without the help of a financial adviser.
The tapered annual allowance has caused real issues within the NHS with media reports flagging that many doctors and consultants are cutting back their hours as they are inadvertently breaching these limits and incurring sizeable tax bills.
A system that results in such dire unintended consequences is one that is clearly not working.
It is time this web of annual and lifetime allowances was simplified to bring clarity to people’s retirement planning.
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