Written by Tom Selby, head of retirement policy at AJ Bell
The rising cost of living is now affecting the lives of millions of Brits and forcing people to take financial decisions they might otherwise not have contemplated, including accessing their hard-earned retirement pot. This could be to help cover their own bills, or to provide help to relatives or friends.
The Bank of England is forecasting a substantial increase in the unemployment rate in the coming years – from 3.4% in Q4 2022 to 6.4% in Q4 2025 – further pressuring people’s already squeezed incomes. In short: things are likely to get tougher in the coming months and even years.
Regardless of the motivation or circumstances, anyone who accesses even £1 of taxable income flexibly from their retirement pot faces having the annual amount they can save tax-efficiently in a pension slashed from £40,000 to just £4,000. What’s more, they lose the ability to ‘carry forward’ unused allowances from the three previous tax years.
Punishing those who access their retirement pot as the rules intend with such a swingeing cut to their annual allowance is deeply unfair and will leave many hamstrung when looking to rebuild their pension after this crisis.
Some of those affected will also find themselves in a position where they need to make up for lost time. Savers in their late 50s, in particular, risk being caught in a pensions ‘no-man’s land’, having joined the workforce at a time when defined benefit (DB) provision was being phased out in the private sector and being automatically enrolled into a workplace pension too late in their lives to build a fund sufficient to meet their retirement needs.
This means they are more likely to need to contribute larger sums to their pension as they approach retirement to make up for years when they have failed to save enough. The MPAA severely restricts their ability to do so, meaning there is a greater risk they will eventually fall back on the state.
How the MPAA risks leaving middle Britain stranded
Take a 55-year-old who has saved £100,000 in their defined contribution (DC) pension through auto-enrolment who has already taken their 25% tax-free cash. If they withdraw £10,000 of taxable income from their fund – for example to help with their children’s mortgage bills or to pay for care for an elderly relative – the maximum they can contribute each year falls to £4,000, in line with the MPAA.
If they contributed the maximum allowed under the MPAA, assuming 4% investment growth post-charges, by age 66 their fund would be worth around £207,000.
If we again assume 4% investment growth throughout retirement, that £207,000 could provide an annual income in drawdown for 30 years, rising each year in line with inflation, of £9,000. And, of course, there will be those who have saved much less than this in their 50s who will be hit by the MPAA and find themselves in an even more difficult position when it comes to their retirement.
Discouraging good long-term savings behaviour
The MPAA also risks undermining the drive to boost long-term savings levels through automatic enrolment. While someone contributing 8% of band earnings (the legislative minimum) would not breach the MPAA, most people – and particularly those who have failed to save enough when they were younger – should be aiming for higher contribution levels than this.
Someone earning £55,000 who is auto-enrolled at 8% but has this contribution based on total salary would breach the MPAA by £400, and therefore be subject to an annual allowance tax charge.
Even a saver earning £45,000 who is a member of a moderately generous scheme where 10% of salary in total is contributed to their pension would exceed the MPAA by £500. The MPAA therefore isn’t just targeting the super-rich – far from it. It is hitting ordinary working people and risks storing up future problems by discouraging sensible retirement saving decisions.
The proposed solution
To send out a message to hard-working savers that the Government is on their side, we recommend the Treasury should, as a minimum, increase the MPAA to £10,000 as soon as possible.
Over the medium-term, there is merit in considering whether there is a simpler way to manage the risk of pension tax-free cash recycling.
In fact, there are existing pension recycling rules which could be adapted to deter anyone tempted to exploit the system. These potentially offer a route to abolishing the MPAA altogether by treating a payment as ‘unauthorised’ if it seeks to exploit the system.
