Women are most likely to be hit hardest by the money purchase annual allowance, which Legal & General Investment Management has described as a 'pension tax penalty'.
According to LGIM, the MPAA, which affects more than 25 per cent of retired Brits, could not only wipe out up to 90 per cent of the individual's taxable benefit - but it also disproportionately affects women.
The MPAA reduces the annual tax-free amount a saver can pay into their pension from £40,000 a year to just £4,000 – a penalty that kicks in if the saver withdraws more than the 25 per cent tax-free lump sum allowed from their pension at retirement age.
The current age for pension freedoms - the age at which one can access their workplace pension is 55 but rising to 57 in April 2028.
For this reason, many people across the financial services industry have called on the government to change the MPAA ahead of the Budget next week (October 27).
However, despite warnings from companies such as LGIM warning about the pension tax penalty, thousands of people still get caught out by it each year, and it is women who are hardest hit.
According to research by LGIM, 31 per cent of women in defined contribution pension schemes are affected negatively by the MPAA, compared to 22 per cent of men.
This is because they are unaware taking more than the tax-free cash from their pensions at retirement age means that, should they continue to pay into their pension from age 55, they will get hit by the MPAA.
Rita Butler-Jones, co-head of DC at LGIM, said: “The option to take a tax-free cash lump sum from a pension is probably the best-known perk, yet so many savers admit that they would make different choices when given more information.
"In fact, our data shows that women in particular have a greater response rate when communicated to by pension providers so there is a clear desire and willingness to make better-informed choices.
“However, too often we see women are left worse off financially as a result of the stark gender pensions and pay gaps and this imbalance continues through poor choices as they move into retirement."
She added financial services needed to do more to "educate and inform" members of all the options that are available to them, so they can make the right financial decisions for their future.
LGIM's research, carried out among 1,526 members of UK DC pension schemes who were aged 50 or older, found 56 per cent had never heard of the MPAA.
After explaining the concept, 27 per cent said it would affect them.
Women were more likely to be hit by the penalty, particularly as 33 per cent of women are more likely to withdraw their tax-free cash at 55, compared with 22 per cent of men. Women, who already tend to have smaller pension pots, are most at risk if they take out their cash lump sum.
Too often we see women are left worse off financially.Butler-JonesThe LGIM research also showed more women than men were likely to put their tax-free cash into a saving account, such as an Isa, at 29 per cent compared with 19 per cent of men.
However, when shown the potential return differentials of a pension versus a cash Isa over the past 10 years, 47 per cent of those who had already taken part or all of their tax-free cash, said it would make them think twice about taking out more tax-free cash than they needed.
A further 43 said it made them reconsider withdrawing any tax-free cash from their pension at all until they reached retirement.
Meanwhile, 40 per cent of respondents were not even aware that they could take less than the 25 per cent.
Easier 'than you think' to trigger the MPAA
This is not the first time a major provider has highlighted issues with the MPAA. In August this year, as reported by FTAdviser at the time, pension provider Aegon warned that people on moderate earnings could have their retirement plans "damaged" by the tax penalty.
Its analysis found individuals earning £30,000 a year would trigger the MPAA with monthly pension contribution rates over 13.4 per cent.
At the time, Aegon warned: "The suitability of the MPAA has already come under pressure with changing retirement patterns, as an increasing number of people are accessing their pension flexibly to support a gradual transition to retirement.
"However, the coronavirus crisis has brought the £4,000 contribution limit under further scrutiny. This is because over 55s facing financial difficulty during the pandemic may have dipped into their pension for short-term financial relief but will now find themselves restricted to the MPAA limit for any future pension contributions."
Aegon's analysis showed moderate earners could hit the 4,000 MPAA limit more easily than one might think. As the table above shows, the likelihood of hitting the MPAA after age 55 would fall to 8 per cent for someone earning £50,000 per year.
Aegon said it was important for people to remember the £4,000 limit also includes tax relief and any pension contribution from the employer.
simoney.kyriakou@ft.com
