Aegon has warned that in their eagerness to take advantage of the new pension freedoms, many savers in their mid-to-late fifties will accidentally trigger a reduction in their annual allowance.
Kate Smith, regulatory strategy manager at Aegon, explained that if savers do something that triggers a reduction in their tax relieved annual allowance, it drops from £40,000 to £10,000 which can be “significantly detrimental” to future retirement plans.
The majority of those in their fifties will be at the peak of their pension contributions, but this could be across numerous schemes, or if someone moves to a new job, they are likely to be auto enrolled and start making new contributions, which could inadvertently hit the limit.
The annual allowance drops to £10,000 when a saver gets cash or a short-term annuity from a flexi-access drawdown fund, cash from a pension pot via the uncrystallised funds pension lump sum option, or more than the limit from a capped drawdown fund
Ms Smith suggested several ways to avoid this scenario, firstly buying a traditional, inflexible annuity.
“You can take 25 per cent of your pot as tax-free cash and use the remainder to buy the annuity and continue to make tax-efficient contributions up to the maximum annual allowance of £40,000 in the years ahead,” she pointed out, warning savers not to buy a new-style flexible annuity, as this is a trigger for the reduction.
The second option is to go into income drawdown and only take a 25 per cent tax-free lump sum.
“So long as you don’t go on to take a retirement income, you won’t trigger the reduction in your annual allowance,” said Ms Smith.
“This option offers access to your money and your annual allowance isn’t affected until you’re ready to start taking the other 75 per cent as income - you also get the additional flexibility of being able to continue to grow your unused fund.”
She added a third possibility is to use the new small pots rule that allows people to cash in pensions with an individual value of up to £10,000 – a lifetime limit of three applies to contract-based schemes, such as personal pensions, although there is no limit on some types of occupational pensions.
“In this new world of pension freedoms the government has ultimately given you better access to your money,” said Ms Smith, adding that the trick is to avoid stumbling into the unseen snakepits that this freedom creates.
The annual allowance has come under attack recently, with the Conservative Party manifesto mentioning plans to reduce it from £40,000 to £10,000 for very high earners, while Labour proposed to fund spending pledged by decreasing the annual allowance too.
peter.walker@ft.com
