The money purchase annual allowance (MPAA) has trapped almost one million over-55s, who must now live with a permanent reduction to the amount they can put into their pension tax free.
For individuals wishing to dip into their retirement pots using the pension freedom rules, tax relief is available on contributions up to £40,000 a year, but those who have already made a flexible withdrawal, instead become subject to the MPAA of £4,000 a year
Experts fear that many savers who took cash from their pensions are unaware that their tax relief limits have been slashed.
“While accessing the money is easy, grasping all the future tax implications is much more difficult. We now know that more than a million people are subject to stricter rules that dramatically reduce the tax efficiencey of pensions and increase the potential for inadvertently triggering tax charges.”
Data from HM Revenue & Customs has revealed 980,000 over-55s who used the pension freedoms between 2015 and 2019 have been caught by the MPAA, the Financial Times reports. As a result their annual allowance has been cut from £40,000 to £4,000.
The figures were released following a freedom of information request by Just Group. Speaking to the paper, Just Group communications director Stephen Lowe called on the regulator to ensure people are able to receive "independent and impartial guidance to prevent people from making uninformed, irrevocable choices that can cause harm".
The MPAA was set at £10,000 in April 2015, when the freedoms first came into force. However, this was cut to £4,000 by chancellor Philip Hammond in 2017. At the time, the Treasury said the government "does not consider earners aged 55 and over should be able to enjoy double pension tax relief, such as relief on recycled pension savings".
On average, 70,000 people each quarter have withdrawn a lump sum, meaning the total to date has potentially exceeded one million.
Stephen Lowe said: "While accessing the money is easy, grasping all the future tax implications is much more difficult. We now know that more than a million people are subject to stricter rules that dramatically reduce the tax efficiency of pensions and increase the potential for inadvertently triggering tax charges."
The MPAA is the total input across all money purchase schemes and it covers any contributions made personally, by an employer or by any third party.
Taking a 25% tax-free lump sum from a pension is not a flexible payment and the MPAA would not apply, but any subsequent withdrawal is classed as a flexible payment and triggers the tighter limits.
"Many people dipping into pension money fully expect to continue making contributions for years to come. Let's be clear, it's not the super-rich who are going to get caught out by perhaps someone on a reasonable salary who gets a good promotion, a self-employed person or director who has a profitable year, or someone who missed a few years of contributions and wants to catch up," Lowe added.