The hidden cost of the drive to get over-50s back to work

The money purchase annual allowance could cost £50,000 in missed investment value over 12 years for pensioners returning to work, interactive investor research finds.

The government is rumoured to be considering upping the lifetime allowance for pensions from £1,073,100 as part of a drive to encourage the over-50s back to work.

But new calculations by interactive investor, the UK’s second largest direct-to-consumer investment platform, show that efforts to provide a financial incentive for pensioners to return to work could be undermined by the Money Purchase Annual Allowance (MPAA).

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The MPAA restricts the amount you can pay into a pension and still receive tax relief once you start to draw an income your pension pot.

For most people, the total amount that can be contributed to their pensions each tax year and still receive tax relief is £40,000 (including any contributions from your employer). But if you trigger the MPAA, this reduces to £4,000 a year.

interactive investor’s calculations show that a 55-year-old higher rate taxpayer, who has already accessed their private pension and contributes £1,000 a month into a pension until age 67 would incur a tax charge of £38,400 in total over the 12-year period (£3,200 a year) on total contributions of £144,000 because of the MPAA.

A £1,000 pension contribution is a significant amount to contribute for the privileged few, but given the skills shortage and the government aim to encourage the over-50’s back to work, it’s right that these numbers, while unattainable for most, are explored.

Assuming that the pot grows by 4.5% a year (5% investment growth minus 0.5% fees), this amounts to missed investment value of almost £50,000 (£186,576 with full tax relief minus £136,822 after MPAA charge).

For a basic-rate taxpayer, the total tax charge of £19,200 amounts to missed investment value of almost £25,000 over 12 years.

A lower monthly pension contribution of £500 would result in a tax charge of £9,600 for a higher-rate taxpayer (£800 a year) and missed investment value of £12,439 over the 12-year period on contributions totalling £72,000.

For a basic-rate taxpayer, the tax charge of £4,800 amounts to missed investment value of almost £6,219 over 12 years.

Whereas contributing £333 a month (£3,996 a year) falls within the MPAA of £4,000 a year and would, therefore, be eligible for pension tax relief. This is the max a returning worker who has drawn income from their pension can contribute to stay below £4,000 MPAA, so as not to trigger an additional tax charge.

Potential tax charge and missed investment value on pension contribution over 12 years resulting from the Money Purchase Annual Allowance

Assumptions: retirement at 67, basic-rate tax taxpayer, investment from age 55 to 67, 5% investment growth, 0.5% fees. These scenarios should not be taken as advice.

Alice Guy, Personal Finance Editor, interactive investor, says: “The pension rules create a harsh two-tier system where older workers are unfairly penalised for taking time out from the workplace. 

“Someone who has taken a break and dipped into their pension pot could end up with a huge, unexpected tax bill, making it much harder to save for a comfortable retirement. In contrast, someone who was able to carry on working can potentially save a much higher amount into their pension.

“The money purchase annual allowance rules are extremely complex and little-understood, adding to the sense that pensions are complicated and not for everyone. They are also unfair because they only apply to workers with a defined contribution pension, not those with defined benefit pension schemes. The MPAA rules won’t usually be triggered if you take a tax-free lump sum, but they will if you start drawing an income, for example.

“Under the current MPAA rules,  if you’re made redundant at 55, decide to draw a pension income to tide you over, and then return to the workplace, you would only be allowed to pay £4,000 (including employers’ contributions and pension tax relief) before triggering a tax charge. Someone contributing £500 per month to a pension could be hit with an £800 tax bill at the end of the year, while someone contributing £1,000 per month could have to pay up to £3,200 extra tax each year.

“It’s also not uncommon for workers to enter their 50s with a fairly small pension pot and want to prioritise pension saving later in their working life. But the shocking truth is that workers trying to make up for lost time and pile money into their pension could end up losing as much as £50,000 in lost investment wealth due to the punishing money purchase annual allowance rules (assuming they invest £1,000 per month in their pension for 12 years and are a higher-rate taxpayer).

“With the state pension age going up and more people working for longer, pensions need to be flexible and offer options to older workers. People often have different life phases and may need to take time out to care for loved ones, recover from health problems or retrain for a new job. It’s crucial not to increase barriers for older workers who want to return to the workplace and continue building their wealth for retirement. 

“Saving for a pension is a marathon, not a sprint, and the rules need to make it as easy as possible for those on the final lap and heading towards retirement.”

Myron Jobson, Senior Personal Finance analyst, interactive investor, says: “The rumoured increase in the pension lifetime allowance and other efforts to get the nation’s most experienced and knowledgeable minds back to work to ease the ‘brain drain’ in the labour market are potentially being undermined by the MPAA, which significantly pares the carrot of tax relief on pension savings.

“This weakens the financial incentive for early retirees to fill key roles, notable for former NHS doctors who have been discouraged from working because of the existing lifetime allowance. High earners could also be hit by the tapered allowance, which places further limits on the amount of tax relief high earners can claim on their pension savings.

“The MPAA isn’t intrinsically wrong – it prevents pensioners from gaming the tax system and getting double pension relief on recycled pension savings. That wasn’t what the pension freedoms introduced in 2015 were intended for. It is right that MPAA is set at a level that focuses government support on those who genuinely need, rather than simply choose, to draw on their pension savings and who subsequently find themselves able to re-build their pension through employment. The government has a tricky task in balancing this with the need to incentivise older workers, who have already drawn income from their pension, to go back to work to help kickstart a stuttering economy. Restoring the MPAA limit back to £10,000 could help the government strike a balance.”

Background

The Money Purchase Annual Allowance was introduced as part of the pension freedoms in 2015, to control the risk pension savers might use the freedoms to circumvent the tax system. Someone over age 55 could do this by having income paid into their pension and then drawing it out using the pension freedoms, thereby receiving 25% tax-free. Without the MPAA, there would be nothing to stop someone ‘washing’ their income through the pension system up to the annual allowance every year.

In its response to the pension freedoms consultation, published in July 2014, the government said: ‘The government will be closely monitoring behaviour under the new system and will work closely with industry to ensure the system remains fair and proportionate.’ 

The government subsequently announced in 2016 its intention to reduce the MPAA from £10,000 to £4,000. At the time it stated: ‘The current MPAA of £10,000 is more than three times median DC contributions made by men aged 55+ and five times median DC contributions for women in the same age group. Only 3% of individuals aged 55+ make DC contributions of more than £4,000 a year. Setting the MPAA at £4,000 would ensure that where a person remained in, or returned to, employment having drawn benefits flexibly, pension savings could be made at a level that is above those required under automatic enrolment. The maximum legally required savings under automatic enrolment are currently £743, rising to £2,974 from 2019.

Where additional support is offered for saving after a pension has been accessed flexibly, the government wants to focus it on those who genuinely needed, rather than simply chose, to draw on savings and who subsequently find themselves able to re-build some pension. People in this situation might include individuals who 

•           have divorced or separated 

•           have been made redundant 

•           have been declared bankrupt