Pensions are a fantastic tool for retirement planning, yet they can also be complicated. This increases the chance that you can make costly mistakes, especially if you don’t seek professional advice. Below, our team of Financial Planners at Vesta Wealth highlight four common pension mistakes, together with some ideas on how to avoid or address them.
#1 Watch out for the MPAA
The MPAA, or Money Purchase Annual Allowance, limits how much you can keep paying into your pension pot(s) once you start withdrawing. Many people mistakenly think that they can retire from age 55, continue working and receive the same tax relief as they did before. However, this is often not the case.
If you trigger the MPAA rules, you can only contribute up to £4,000 into your defined contribution pensions each tax year. Since this is a relatively low limit compared to the standard annual allowance (see #2 below), you need to be sure before triggering the MPAA rules. The range of triggers is complex, but common ones include taking your entire pot as a lump sum or moving pension money into flexi-access drawdown and taking an income. The answer here is to seek financial advice before accessing your pension for the first time.
#2 Failing to maximise your annual allowance
Under current rules, you can contribute up to £40,000 into your pension savings each tax year, or up to 100% of your salary (whichever is lower) assuming the MPAA rules have not been triggered. Whilst this is a much lower amount than the £255,000 annual allowance available in 2010, it is still more generous than the £20,000 limit offered by an ISA.
Pension contributions are so powerful because they receive tax relief equivalent to your highest rate of income tax. However, many people do not take full advantage. One little-known rule called carry forward lets you make use of any unused annual allowances from the prior three tax years (i.e. up to £120,000). This can help you make up lost ground if you have delayed putting into your pension. Speak to your Financial Planner if you are interested.
#3 Not keeping track of your pension savings and tax relief
There are two main types of pension scheme apart from the State Pension: defined contribution schemes (involving a pension “pot”) and defined benefit schemes (where your employer promises you a certain retirement income). Within these categories, however, many internal scheme rules exist and can vary widely. Some schemes, for instance, do not penalise you with exit fees if you want to transfer to another, whilst others do. Certain defined benefit schemes continue to offer benefits to your spouse/partner when you die, but not all do.
Make sure you understand how your scheme(s) work. Assumptions you have about them may be incorrect and could undermine your retirement plans later. If you have multiple pension pots to deal with, then your Financial Planner can help you work through them all and – if appropriate – bring them together under a single pot (via pension “consolidation”).
Also, be careful to follow tax relief rules correctly. A Basic Rate taxpayer who solely contributes to a workplace pension pot usually gets 20% tax relief, which is arranged by their employer and scheme administrator. However, those on the Higher Rate need to claim the extra 20% relief via their self-assessment tax return.
#4 Mind the pension “ceiling”
Not only is there an annual limit on your pension contributions, but there is an overall limit called the Lifetime Allowance (LTA). This is set at £1,073,100 in 2021-22 and has been frozen until 2025-26. Once you breach this threshold, any excess money taken as a lump sum from your pension(s) is subject to 55% tax. Any excess taken as income will be taxed at 25%.
It is easier than you might think to exceed the LTA, especially for higher earners, such as GPs and senior public sector workers. This is partly because compound interest is a powerful force on your investments which can be hard to predict the further away you are from your retirement date. This is another strong reason to plan your retirement as soon as possible, since this gives you more time to adjust your strategy if you are in danger of going over the LTA.
Different options can be explored, here, to help keep you within the limits. One idea is to start de-risking your portfolio the nearer you get to your retirement date. This can make sense for lots of people anyway since their priority shifts from wealth growth to wealth preservation as they prepare for their drawdown phase of life.
Another idea is to explore other tax-efficient investment vehicles to help fund your retirement such as a Stocks & Shares ISA. Whilst not free from inheritance tax (IHT) like a defined contribution pension is, ISAs do not have a total cap on your investments and any gains are free from capital gains tax (CGT).
Invitation
If you would like to discuss your pension(s) and retirement strategy, then we would love to hear from you. Get in touch with your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.
Reach us via:
t: 01228 210 137
This content is for information purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice regarding your affairs please consult your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.