In April 2015, the government introduced the concept of ‘pension freedom’ and the related Money Purchase Annual Allowance. In Chancellor George Osborne’s Budget, he outlined plans for defined contribution pensioners to access their pension pot, or a portion of it, once they’d reached the age of 55.

At the time, concerns were raised over this new so-called freedom. The BBC reported fears of a new wave of fraud, and many became worried that their pension pot would run out of money before they died.

There are currently 6 ways you can take your defined contribution pot – the first 25% of your accumulated pension funds can be taken out tax-free.

What can pension savers over 55 do?

• Leave your pot untouched

There is no requirement that you access some or all of your pension pot at 55. While money stays in your pot, returns on it remains tax-free though it’s important to note that the investment could go up or down depending on inflation and the length of time it is left.

• Buy an annuity (guaranteed income) If you choose to do so, you may use your pot to buy an insurance policy known as an annuity. This guarantees you income for the rest of your life, no matter how long you live. Annuity rates have not been great lately though.
• Invest in an adjustable income You take out 25% of your pot as a one-off tax-free sum. You invest the other 75% of it to give you a regular, taxable income.
• Take out cash in chunks Some people choose to take out smaller chunks of cash until their pension pot runs out. Each time you do so, 25% is tax free and the rest is taxable.
• Take your whole pot out in one go You can take out your pot in one go, should you choose to do so. 25% of this is tax-free.

Mix it up!

If you can afford it, you may wish to consider mixing options. Find out more information on mixing options here.

What is the Money Purchase Annual Allowance?

If you choose to take money out of your pension pot, you’ll need to be aware of the Money Purchase Annual Allowance (MPAA). This new pension tax was launched when the new freedoms came into place to prevent savers withdrawing from their pensions before re-investing it so they could capitalise on the tax breaks.

At the time, a higher-rate taxpayer may have taken £24,000 from their pension in cash. As long no more than £40,000 had been paid into their pension fund that year, and the £24,000 was paid back into the pension, the government would top it up with an additional £16,000.

Of course, this was something the government wanted to stop.

The MPAA currently stands at £4,000 and makes you liable for tax if you or your employer exceeds the limit in pension contributions within a single financial year. The amount payable is equivalent to the sum you’d pay if you’d been paid the excess as income tax.

How does this affect my annual limit for pension tax relief?

Previously, the annual limit stood at £40,000. Now, you can save £4,000 with tax relief.

For those who wish to work until State Pension Age, but chose to withdraw money at 55 or older, it’s crucial that you realise your pension will not grow anywhere near as quickly as it used to.

So, when deciding on whether you want to take out money from your pension pot, be wary. Income you invest into your pension after taking the 25% tax-free allowance, regardless of where it comes from (rental income, company dividends, and so on), will be subject to a limit of £4,000 tax-free savings.

For more information on how best you can manage your pension, get in touch with the Burton Beavan team today on 01606 333 900 or email hello@burtonbeavan.co.uk.