Using pension freedoms could mean a £4,000 maximum annual pension contribution limit

Posted by | December 04, 2016 | Budget, News, Pensions, Politics, Tax

The Autumn Statement passed relatively benignly and only time will tell whether our new Chancellor has saved his best for the March 2017 Budget. Certainly the one area of pensions reform which all professionals seem agreed on, the possible abolition of the pensions Lifetime Allowance, was notable for its absence or indeed any reference to pension contribution limit changes, bar one which has seemingly snuck under the radar.

The Chancellor has further cut back the amount which can be contributed into pensions for anyone who has also accessed their pension flexibly, i.e. withdrawn a sum in excess of the allowable tax free lump sum from their pension. Prior to the Autumn Statement, anyone entering flexible drawdown was thereafter restricted to an Annual Allowance for pension purposes of £10,000. From April 2017, the allowance will reduce to £4,000 per annum. In summary, for drawing funds other than a tax free lump sum from your pension, you will then only be able to contribute up to £4,000 per annum into pensions.

For those in “traditional” retirement, i.e. those people who have ceased work and are looking to draw from rather than contribute into pensions in the future, this change will have negligible impact. However, increasingly flexible drawdown has been used by those still in work to fund ad hoc expenditure such as a wedding, mortgage repayment or a gift to a child for a property deposit, for example. Those individuals are still actively contributing into pensions and whilst the £10,000 limit wasn’t ideal, it provided more scope than a limit of £4,000.

For those individuals looking to contribute more than £10,000, then flexible drawdown wasn’t an ideal solution, because they needed the scope to contribute more and so the reduction acted as a disincentive to commence flexible drawdown. The latest reduction will put more people off accessing their pension early, but perhaps it will serve to put the wrong people off. For example, someone who genuinely needs or wants to access their funds, understanding all the risks, whilst looking to contribute ongoing in the future. This is someone who should be encouraged to save, rather than prevented. Those people looking to access funds early for the sake of it and for their future detriment will not be caught by this legislation.

This Autumn Statement move didn’t grab many headlines last week, but this is something which needs highlighting to avoid people falling into a trap they can’t get out of.

Those in capped drawdown rather than flexible drawdown will remain unaffected by this legislation and some consideration is being factored in for final salary benefit accrual and contributions, but there is a risk, which the Treasury will need to address for members of auto-enrolment schemes. It is conceivable that when we reach the maximum auto-enrolment contribution levels, someone in flexible drawdown may find themselves contributing more than £4,000 per annum and in breach of their reduced Annual Allowance. The reduced Annual Allowance is monitored retrospectively and no barriers will be in place to stop someone over-contributing just as there aren’t with the standard Annual Allowance.  It isn’t something an employer or pension provider will prevent happening. The onus will be on the pension scheme member to monitor their own contribution levels. Something which won’t be possible if this legislative change is not highlighted.

It is curious that of all the changes that the treasury could have made, they chose to tinker rather than reform, perhaps the bigger changes are ahead.