Pension warning as Britons at risk of savings ‘trap’ which ‘reduces tax efficiency’

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Retirement expert advises people to learn about state pensions

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Pensions can be great vehicles for saving money for retirement. However, those who choose this option must be aware of the rules which come along with it.

At present, Britons can access their pension from the age of 55 under pension freedoms rules.

This is good news for those who may need an extra bit of cash before they retire.

However, individuals should be aware accessing cash before retirement could mean they trigger a key allowance.

In turn, this could restrict how much they can save tax-efficiently in future.

In most cases, individuals can contribute 100 percent of their annual earnings up to a maximum of £40,000 into their pension each tax year.

They will get tax relief on these contributions at the highest level of income tax they pay, offering a valuable boost to one’s pension.

But withdrawing money before retirement means individuals could trigger what is known as the Money Purchase Annual Allowance (MPAA).

Experts have described this as a pension “trap” as it could reduce the amount a person can save from £40,000 down to £4,000.

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As the MPAA impacts how much a person can save tax-efficiently into a pension, it is a particular concern for those who are still working.

If accessing a pension at 55, but not retiring for years to come, it can impact how much individuals can save and thus their pension pot might be much lower than originally anticipated.

Michelle Crowley, wealth planner at Succession Wealth, said: “You’ve spent your career saving into a pension to create an income that will deliver a retirement lifestyle you can look forward to. 

“But taking too much too soon or being unaware of tax traps could mean a retirement that you’ve worked hard for and that promised much doesn’t meet expectations.

“If you’re considering accessing your pension before retirement, it’s worth assessing the alternative options whether you want a lump sum or to supplement your income. 

“Using savings or investments could make more sense and allow you to benefit from a higher pension Annual Allowance while you’re still working. 

“There’s no one size fits all solution, so you should review your assets with your goals in mind.”

Individuals can usually take a 25 percent tax-free lump sum from their pension without triggering the MPAA.

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However, this is all dependent on the pension scheme, so it is important to understand the rules.

A large lump sum withdrawal early in retirement could have an effect later down the line when it comes to making money last.

Finally, before a person decides on their pension, Ms Crowley suggested considering financial advice.

Professionals can help a person know whether they are making the right decisions, and offer tailored solutions. 

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