Making up for pension savings drawn during the pandemic
Prospect pensions officer Stewart Mott responds to a member query about making up for pension savings spent during the pandemic and how it could lead to a tax charge.
The COVID-19 pandemic resulted in the sudden and unexpected loss of income for some of our members that would have been unimaginable before March 2020.
Members over 55, or 50 if they had a protected minimum pension age, may have accessed some funds from their pension pots to get by during this difficult and unusual period.
If you have been in this situation, and you are now returning to work and want to replace the pension savings drawn, you need to be aware of the Money Purchase Annual Allowance (MPAA).
The annual allowance is the amount of pension savings we can make in a year and enjoy the benefits of pensions tax relief.
The standard allowance is set at £40,000 per year. If you exceed the standard allowance, you may have unused allowance from the three previous years which you can carry over to negate a tax charge.
When drawing a pension, you can take up to 25% of the value of your pension as a tax-free pension commencement lump sum.
To prevent the abuse of pensions tax relief and tax-free pension commencement lump sums, if you access a defined contribution pension the Money Purchase Annual Allowance may apply. This cuts your annual allowance from the standard £40,000 to £4,000. This does include ‘income drawdown’ which is the most popular product for assessing retirement savings.
Under auto-enrolment the minimum level of total contributions required is 8% of qualifying earnings with a minimum of 3% from the employer. In 2020/21, if you were earning more than £50,270, with an auto-enrolment pension at the minimum levels, the total contributions to your pension would be c£3,500.
Therefore, it is only if you are paying are higher amount than the minimum levels required that you need to be mindful of the MPAA. Even then, most members will not routinely save more than £4,000 into their pension.
If you are looking to make up funds that were drawn during the pandemic with a very high level of contributions, then the MPAA needs to be considered to ensure you do not receive an unwelcome tax bill seeking to reclaim pension tax relief above the MPAA.
If you are looking to rebuild pension savings or just planning for retirement, how much income you are going to need in retirement is important to understand. As well as how much income you are on track to save.
The Pension and Lifetime Savings Association have developed income standards to help individuals and couples get an idea of how much income is needed in retirement. These standards give an idea of the level of income required for different standards of living in retirement.
These can be a helpful target to aim for when saving for retirement. The minimum level of income required for a basic standard of living is £10,000 for an individual, or £15,000 for a couple. The Pensions and Lifetime Savings Association provides detailed information on the living standards.
If you would like to estimate the annual income you could expect from your pension savings and the amount you are currently contributing, the Money and Pension Service have a calculator.
Prospect is not authorised or regulated by the Financial Conduct Authority to provide personalised financial advice. The content of this blog is for general guidance only.