Pensions Doctor ‘I cashed in a £10k pension – now I’m caught

In a tax trap’

QSeveralyears ago, we had to close down our business, leaving us without any income or savings.

Without receiving any advice, we decided to access one of my husband’s “money purchase” pensions, as he had reached the minimum pension age of 55. This was a cash lump sum of more than £10,000. It is only since we have both started new jobs that we have realised my husband must have triggered the “money purchase annual allowance”. Should he stop paying into his pension once he has paid £4,000 a year (the limit)? His employer also pays in. He could start an Isa but he would miss out on employer contributions, so would he be better off continuing to pay over the limit into his pension and deal with the tax consequences later? Anon, via email

AI

am sorry to hear about your business. You’ve been through a tough time.

But it is positive that you and your husband are both now employed, have access to a workplace pension and are in a better position to rebuild your financial future.

From your 55th birthday you can flexibly access your money purchase pension as and when you like, as a cash lump sum or income from a “flexiaccess” drawdown account. But as you’ve found, taking out money under the flexible access rules and doing it earlier than intended can have long-term consequences, on both your ability to rebuild your pension and on your standard of living once you come to retire.

Due to the cost of living squeeze it is likely that more people will access their pensions earlier than planned just to make ends meet, without realising the consequences of doing so. Likewise, many dipped into their pensions during the pandemic.

Pension tax rules limit the amount you can save in a pension, without attracting a tax charge. The standard annual allowance is £40,000 – this is the maximum that can be paid into a pension each year by you, any third parties and your employer, without being subject to a tax charge. You can only pay more than this in a tax year if you have unused allowances which can be carried forward from the three previous tax years. Tax relief on personal and third- party contributions is normally limited to 100pc of your relevant UK earnings each tax year.

THE ‘MONEY PURCHASE’ ALLOWANCE As soon as an individual takes money out of their pension ( beyond the taxfree amount) they trigger the money purchase annual allowance.

This means the amount of contributions saved in a money purchase pension scheme before attracting a tax charge plummets by 90pc, to only £4,000 each tax year.

Once this happens, there is no return to the £40,000 allowance and it is no longer possible to carry forward unused annual allowance.

Your husband has triggered the money purchase annual allowance. This makes it extremely challenging for him to rebuild his pension.

Your husband’s pension provider should have issued him with a “flexible access statement”, letting him know he had triggered the money purchase annual allowance, and should have done so within 31 days of him cashing in his pension.

It is your husband’s responsibility to notify his new workplace pension provider that the allowance has been triggered or he could be fined.

It is possible to pay in contributions above the £4,000 amount. But any excess contributions, whether they are paid by your husband, his employer or a third party, will attract a tax charge. For example, if the total pension contributions paid in the 2022-23 tax year to money purchase schemes is £6,000, this would be £2,000 above the £4,000 money purchase annual allowance limit. This excess would be subject to tax at marginal rates of income tax.

Broadly, the £2,000 would be added to your husband’s reduced net income ( the income on which your husband pays tax). Assuming reduced net income of £60,000 would give a total of £62,000. The £2,000 is subject to tax at 40pc meaning a tax charge of £800 would be due.

Depending on the figures for any particular case, a tax charge could be 20pc, 40pc, 45pc or a rate somewhere in between if the excess is subject to tax at two different rates.

The effect of the tax charge will remove any tax benefits he received from making pension contributions. As your husband may be faced with a large tax bill, it may be worth considering reducing his contributions to his workplace scheme to avoid the tax charge in the first place. Once an individual has triggered the £4,000 allowance, there is no going back and there is no appeals process. This applies to everyone regardless of the reason for flexibly accessing benefits.

As a couple, you could consider pooling your resources to maximise your joint potential retirement income. Your husband could also pay into your pension. But he should check to see how much he needs to contribute to his workplace pension to continue receiving employer pension contributions. Reducing or stopping his own pension saving could mean he loses his employer pension contribution.