Do you hear about the pension 'trap' read on for clarity!

PENSIONS

Work after 65 - is there a pension trap?

An article has suggested that there’s a pension trap that could result in tax bills for over 65s who are still working. Is this “pension trap” something to worry about? A tax payer, who recently turned 67, owns and runs a company wanted to know more…..

Is the article correct?

The article referred to above followed the release of official statistics showing that record numbers of over 65s are re-joining the workforce. The “trap” is real, but exaggerated by the article.

Not just over 65s

The article misses an important point. That is, the trap can apply if you’ve withdrawn from a money purchase pension and then pay into another. Currently, you can access your pension savings if you’re 55 or older. The article mentioning those aged 66 is misleading although it’s a factor that we’ll explain later. Tip. If your pension is a final salary scheme (these are few and far between these days) you don’t need to worry as the trap only affects money purchase type schemes. From now on when we refer to pension savings or schemes, we are only referring to money purchase schemes.

What’s the trap?

You may ask how can paying into a pension, something that normally qualifies you for tax relief, land you with a tax bill? The answer is that the tax relief on contributions is capped at a special low level (the money purchase annual allowance (MPAA)). It limits relief to contributions of just £4,000 per year. The chances are that if you have retired at 55 or older and re-entered the workforce you’ll have accessed your private pension.

Contributions exceed the MPAA

You might think the way to avoid the trap is simply to not claim tax relief on contributions in excess of the MPAA, but there’s a problem. Basic rate tax relief is automatically given on contributions. For every 80p you pay, the government chips in another 20p. The solution seems obvious; don’t contribute more than £3,200 (£4,000 with the government’s input). Trap. That solution is fine if you’re self-employed because how much you contribute is entirely up to you, but if you’re an employee (or director) the position is not so clear.

Workplace pensions

Until you reach 66 you’ll be automatically enrolled in your employer’s workplace pension. If you’re older you will be invited to join voluntarily. Total workplace pension contributions payable by you and your employer are usually 8% of “band earnings”, although it can be higher (click here for further information). Here again the article is misleading. It implies that workplace pension contributions for a person earning more than £50,000 will exceed the MPAA (£4,000). In a standard workplace pension the 8% only applies to contributions between £6,240 and £50,270 and so falls short of £4,000. However, not all workplace pensions are standard.

Tip. Avoiding the MPAA trap is simple. If you’re 55 or older and have accessed your pension savings don’t contribute more than £4,000 per year, including contributions from your employer. To achieve this you opt out or choose not to join your workplace pension.

Tax relief is limited to pension contributions of £4,000 per year if you have already taken money from another pension scheme. Tax relief received on contributions above this must be repaid to HMRC. Make sure that your and your employer’s contributions to a workplace or other pension money purchase arrangement don’t exceed the £4,000 limit.