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COVID-19 still hangs over many household’s financial decisions – including how and when to approach retirement. Sadly, many over-55s have seen a reduction in work hours and earnings, leading some to try and “plug the gap” in income using their pension. These kinds of options might seem sensible on the surface, but they should never be taken lightly without independent financial advice.
Here at Cedar House, we wanted to offer our thoughts on four common pension traps we’ve noticed in 2020 as households grapple with the financial implications of COVID-19. We hope you find this article helpful in guiding your thoughts on retirement. Please contact our financial advice team here at Cedar House for more information or to access personalised advice:
020 8366 4400 or enquiries@cedarhfs.co.uk
#1 Tax relief
One of the most common reasons underlying bad decision making on pensions is that many people do not understand their pension scheme, and how tax relief is received on it. In 2020-21, if you are over age 22 and earning over £10,000 per year, your employer will automatically put you onto a workplace pension. From here, your employer will contribute at least 3% and you at least 5% (totalling 8%). The UK government will also “top up” these contributions via tax relief.
This is where it can help to seek financial advice about how to get the best pension deal. If your contributions are paid before you pay income tax, then everything should be automatically taken care of. If, however, you pay your pension after tax (e.g. into a SIPP; self-invested personal pension) you will only receive 20% tax relief automatically. If you’re on a higher tax bracket, then you should be entitled to more. Missing tax relief can be claimed up to four years prior, and it’s important to not miss out on this – especially in the current environment.
#2 Don’t hit the ceiling
Another mistake people can make with their pension is misunderstanding (or not knowing) the annual limit on pension contributions. In 2020-21, you are allowed to put up to £40,000 per year into your pension; or up to 100% of your salary (whichever is lower). Those on higher incomes, however, might not be able to put in as much. For every £2 you earn over £150,000, this £40,000 “annual allowance” is eroded by £1, and this allowance could go as low as £10,000. Be careful to consult your financial adviser about making the most of your allowances, and take extra care about not exceeding them unwittingly.
#3 Money Purchase Annual Allowance (MPAA)
This is perhaps one of the biggest pension traps people are likely to fall into in 2020, as many seek to plug income gaps using their pension whilst continuing pad work. Once you reach the age of 55, most people are allowed to start taking money from their pension pot. Indeed, many have done this in 2020 due to lost work hours. Bear in mind, however, that if you keep working whilst also taking money from your pension, then this is likely to trigger the MPAA rules. These rules reduce your annual allowance from £40,000 per year to £4,000. So, if you plan on using pension withdrawals to boost a short-term income gap and then raise your contributions in the future (i.e. once the economy and your finances recover), then you may not be able to do so. Again, be careful to consult your financial adviser if you are thinking about using your pension to plug an immediate income gap due to COVID-19.
#4 Lifetime allowance
Whilst some may be caught out by the MPAA due to insufficient income and/or savings, others might be caught out due to the lifetime “cap” on pension savings. In 2020-21 the rules regarding the “lifetime allowance” allow each individual to save up to £1,073,100 in their pension(s), and a hefty tax charge is levied on any pension savings which exceed this. Many senior doctors and similar professionals face this possibility, hence some of the reforms by the chancellor earlier this year. For such individuals, it can be enormously helpful to consult a financial adviser about the best options in front of you.
Some might benefit from early retirement – even in 2020, when many headlines suggest that such an option is impossible. Others might benefit from strategies which allow for tax-efficient investing, such as venture capital trusts (VCTs) or the enterprise investment scheme (EIS). Bear in mind that some of these options carry a higher level of risk, along with the possibility of greater investment return. Be careful, therefore, to weigh such investment opportunities carefully with an experienced professional who can help you determine whether they are suitable for your financial goals and risk profile.
Invitation
Many people in the UK are facing significant financial challenges and questions as the UK tentatively edges out of lockdown. This is especially true for many over-55s who are wondering about the best ways to protect, grow and leverage their pension during these difficult times.
We hope this content has gone some way to help/. If you would like to discuss your financial plan with a member of our team, then get in touch today to arrange a free consultation:
020 8366 4400 or enquiries@cedarhfs.co.uk.