Brits planning to take a year off work have been warned they could face a £10,000 pension trap if they use their retirement savings to fund a so-called 'golden gap year'. The trend is seeing people in their 50s, 60s, and beyond take extended breaks from work to travel, volunteer or simply enjoy more freedom after decades of employment and family commitments.
The warning comes as many people prepare to make the most of the final bank holiday of the summer - and potentially start thinking about how they want to spend their later years. PensionBee says taking time out later in life is becoming increasingly attractive, particularly after redundancy, burnout or when children have left home.
The £10,000 pension trap
Unlike a traditional gap year taken at 18, taking a year out at 58 can have consequences for retirement income. One of the biggest issues is the Money Purchase Annual Allowance (MPAA). Someone aged 55 or over may be able to access a defined contribution pension, but taking taxable income flexibly can trigger the MPAA. This can reduce the amount they can subsequently pay into a pension with tax advantages to £10,000 a year.
That could be particularly important for anyone planning to return to work after their year away and rebuild their retirement savings. The normal annual pension allowance is currently £60,000, although some higher earners and people who have already accessed pensions can face different limits.
Maike Currie, VP personal finance at PensionBee, said: “For years, the words ‘gap year’ conjured up images of backpacks, hostels and young people heading off to see the world before starting their careers. But increasingly, it’s older generations who are taking time out.”
She added: “After decades spent working, raising families, paying mortgages and saving for retirement, it’s understandable that more people want to enjoy some of that freedom while they’re fit and healthy enough to make the most of it.”
Checks before booking flights
There are several other financial checks people should make before booking flights. Taking unpaid leave can potentially result in gaps in a person's National Insurance record. People normally need at least 10 qualifying years to receive any new State Pension, while those whose National Insurance record started after April 2016 generally need 35 qualifying years for the full new State Pension. It is therefore worth checking your State Pension forecast before taking a year away from work. Some missing years can potentially be filled through National Insurance credits or voluntary contributions.
A sabbatical or period of unpaid leave could also mean that both employee and employer pension contributions stop, depending on the terms of the workplace scheme. That means the true cost of a year away could be considerably greater than the salary sacrificed. People should check with their employer before leaving work to establish exactly what will happen to their pension.
Keep saving and avoid raiding your pension
Even people with little or no relevant UK earnings can generally receive tax relief on pension contributions of up to £3,600 gross a year, subject to eligibility. Under relief-at-source arrangements, this can mean paying £2,880 personally, with £720 added in basic-rate tax relief. For someone taking a year away, maintaining even modest pension contributions could help limit the damage to their longer-term retirement plans.
Using pension savings to pay for the trip may appear an easy solution, but it can have consequences extending long after the holiday is over. Taking taxable pension income flexibly can trigger the MPAA and leave someone with much less scope to build up their pension when they return to work.
Financial experts also warn against spending every penny on the adventure. Anyone taking a long break should retain an emergency fund and continue to budget for unavoidable costs such as rent or mortgage payments, insurance and household bills. Money should also be set aside for the period after returning home, particularly if there is no job waiting.
Ms Currie said: “A golden gap year is really about buying yourself something incredibly valuable: time. But you don't want the trip of a lifetime to leave a lasting hole in your retirement. Think of it as planning for two journeys at once. There’s the adventure you want to have now, and the much longer retirement still ahead of you.” She urged people to check their State Pension, understand what will happen to workplace pension contributions and think carefully before accessing retirement savings.
The idea of taking a 'golden gap year' comes as Government research has found that 55% of people aged 40 to 75 who had not yet retired said they would definitely or probably consider a Midlife MOT.
