As part of the pensions “simplification” reforms in 2006, the Government introduced a maximum pension pot size, which stood at £1.8m ten years ago. That is equivalent to over £2.8m in today’s money, which would have only impacted people with a pension income of £140,000 or more had that allowance increased in line with inflation.
Since 2012, this maximum ceiling of pension savings has been reduced and is now frozen at £1.074m. In effect, this penalises people with a pension income of around £50,000. And if your pension pot exceeds the LTA, you could face a tax penalty of 55pc.
People often describe the tax incentives associated with pensions as “tax relief”. While you can take up to 25pc of your pension pot tax free at retirement, and the investment growth is free from capital gains tax, your main pension will still be treated as deferred income. This means you must pay tax on that income at the time you receive the money in retirement, this is known as “tax deferment”.
Older highly skilled workers consequently face the threat of significant penalties being applied to that deferred income if they return to work, which reduces the incentive to return.
The “money purchase annual allowance” was first introduced to prevent wealthy investors withdrawing up to 25pc of very large pension pots, tax free from the age of 55, and then recycling that money back into their pension to benefit from the favourable tax treatment of pensions twice.
However, today’s scenario is very different. The policies currently penalise older skilled workers who are not necessarily wealthy individuals looking to exploit the tax system, but have rather lost their job during lockdown or have been forced to dip into their pension pot due to the rising cost of living.
While many of these professional retirees have been pressured to return to work, they have been unable to recover the lost value of their pension pots as future pension contributions are now limited to only £4,000 a year (including tax relief).
A fundamental reform and simplification of our complex series of allowances is very much needed. As a minimum the lifetime and annual allowances should be increased in line with inflation, backdated to the point at which inflation started to exceed the Bank of England’s target of 2pc.
The Government must consider an exemption to the MPAA for people who can demonstrate that the money was accessed to cover rising costs during either the period of Covid lockdowns or the current inflationary environment.
Undoubtedly, retired professionals who re-join the workforce could provide a lifeline for policymakers looking to navigate through challenging economic times.
However, this economic boon will be handicapped where there are unhelpful disincentives applying.
Pete Glancy is head of policy at Scottish Widows