While nobody could claim the UK’s pension system is straightforward, the way people have approached the transition from working to retirement has historically been relatively simple.
The predominance of defined benefit (DB) meant the structure of most people’s pension encouraged them to stop working entirely at a set point in time – usually 60 or 65 – with a set amount of guaranteed income. This might have been supplemented by a smaller personal pension pot bought through a financial adviser.
The state pension system too has been designed based on this ‘clean break’ between working and not working. The state pension ages of men and women will equalise at 65 in 2018 – the women’s state pension age is being gradually increased from 60 at the moment – before rising to 66 in 2020 and 67 in 2028.
The government then plans to bring in a further increase to 68 by 2039 and has explicitly stated it will “aim for up to 32% … as the right proportion of adult life to spend in receipt of the state pension”.
Throughout the pensions system the idea that retirement means stopping working altogether has become deeply ingrained but, for many people, this is starting to change. As DB pensions have all but died off in the private sector, defined contribution (DC) plans have become the main retirement savings vehicle for most people – a trend accelerated by the introduction of automatic enrolment.
Furthermore, pension freedom has created a new dynamic where people are more likely to continue working while drawing from their retirement fund.
Research published by Manchester University and King’s College London on the phenomenon of ‘unretirement’ – not my favourite new pensions term – emphasises this shifting dynamic. The study reveals around one in four retirees in the UK return to work within five years of retiring. Men are more likely to ‘unretire’ than women, as are people who are in good health, those who are better educated and those still paying off a mortgage.
Two important considerations
For any clients planning to go down this route, there are a couple of important things to consider. First, do they have one of the four types of lifetime allowance ‘protection’ which risk becoming void if an extra pension contribution is made? As a reminder, these are: Fixed Protection 2016; Fixed Protection 2014; Fixed Protection 2012; and Enhanced Protection.
This is a particular danger as automatic enrolment means all companies are required to put savers who meet the legislative qualifying criteria in a pension scheme unless they choose to opt out. For savers with protection in place, failure to do so could result in a huge tax bill.
Clients with any of the three other forms of protection – Individual Protection 2016, Individual Protection 2014 and Primary Protection 2006 – can continue to make contributions without being penalised.
Second, if your client has taken any taxable income from their pension – that is, over and above the 25% tax-free lump sum – their ability to continue saving in a pension will be severely restricted by the Money Purchase Annual Allowance (MPAA).
This was previously set at a relatively reasonable £10,000 a year but, from April this year, was reduced to just £4,000. Anyone returning to work after having already taken taxable income from their pension needs either to make sure any auto-enrolment pension contributions do not take them over this limit or accept the fact they will not receive tax relief on pension savings above £4,000.
Tom Selby is a senior analyst at AJ Bell