The Money Purchase Annual Allowance (MPAA) has a much wider reach, as it can affect anyone who has taken benefits from their pension and wishes to continue making contributions.
Below, we explain how the MPAA works and offer some suggestions for avoiding it while making sure your retirement plans stay on track.
What is the Money Purchase Annual Allowance?
Pensions contributions are subject an annual allowance of £60,000 per year. This includes personal and employer contributions, as well as any accrual in a defined benefit scheme. If you don’t use your full annual allowance, and are a member of a pension scheme, you can carry it forward by up to three tax years.
If you exceed the annual allowance, your pension contributions are subject to a tax charge. This is intended to revoke the tax relief received on your contributions and is roughly equivalent to the tax you would have paid anyway. However, as the money is now tied up in a pension, you can expect to be taxed again when you take retirement benefits.
If you are subject to the MPAA, you will have a reduced allowance of £10,000 per year. You also lose the ability to carry forward allowances from previous tax years. For higher earners in particular, the MPAA can severely restrict the amount of tax relief available.
The purpose of the MPAA is to reduce the possibility of ‘pension recycling,’ i.e. making contributions from pension income and receiving tax relief twice.
Triggering the MPAA
The MPAA is triggered when you take a taxable, flexible income from a money purchase pension. This could take the form of a regular drawdown income, an ad hoc lump sum, or encashing your pension fund in full.
Your pension provider is required to write to you and tell you if you have triggered the MPAA. They must do this within 31 days.
The MPAA could apply in the following situations:
- When you take an income from your pension and you are still working. Higher earners may find that employer contributions alone exceed the MPAA. Not all employers are flexible enough to adapt pension provision and it may be a case of paying the tax or opting out of the pension scheme.
- If you take a career break and resume work later. Many people take time out of the workplace, sometimes for health reasons, or because they changed their mind about retirement. If you use your pension to support your lifestyle during this time, you will need to be mindful of the MPAA when you return to work.
- If you suddenly come into money, for example, from the sale of a business or an inheritance. Pensions can offer significant tax relief but your options will be limited if you have already taken benefits.
- If you have a smaller second pension and decide to encash it in full while you are still working, for example, to clear a mortgage.
If you trigger the MPAA, you need to inform any other pension schemes to which you are making contributions. If you don’t do this within 91 days, you could face a fine.
When Does the MPAA Not Apply?
Taking benefits from your pension does not always trigger the MPAA. The following situations are exempt:
- Taking tax-free cash only from your pension.
- Using your pension to buy an annuity rather than taking flexible drawdown.
- Taking an income from a defined benefit scheme.
- Encashing up to three ‘small pots’ worth under £10,000 each.
- Taking income from a plan that was assigned to ‘capped drawdown’ before 2015. The income will be subject to certain limits, but the MPAA does not apply. However, if you later move your pension from capped drawdown to flexi-access, this will trigger the MPAA when you start to take income.
- Withdrawing from a beneficiary drawdown plan following the original owner’s death.
Other Limitations to be Aware of
As well as the MPAA, there are a few other restrictions on pension contributions:
- The annual allowance as mentioned above.
- Anyone can contribute up to £3,600 per year gross (£2,800 net) to their pension, even if they don’t have any income.
- Personal contributions are limited by relevant UK earnings, for example, salary or self-employed profits. If you earn, for example, £40,000 per year, you can pay in £32,000 to your pension and receive £8,000 in tax relief.
- Anyone earning over £260,000 will have their annual allowance reduced by £1 for every £2 over the threshold. The maximum reduction is £50,000, meaning that those earning over £360,000 will have an annual allowance of £10,000.
How to Make the Most of Your Pension Plans
The MPAA can be inconvenient, particularly if you planned to make higher contributions in the years leading up to retirement. The following tips can help you avoid this, as well as maximising the tax benefits on your pensions:
- Keep a healthy cash reserve to cover emergencies and immediate planned spending. This can help avoid the need to dip into your pension early.
- Use your ISA allowance each year to build up a tax-efficient pot that you can access flexibly and without penalty.
- If you do need to access your pension, consider taking tax-free cash and leaving the income element untouched.
- Check if any of your pensions qualify under the ‘small pots’ rules.
- If you have an occupational pension or a capped drawdown plan, think carefully before moving it to access flexible benefits. There may be other ways to meet your objectives.
- If you are employed and have triggered the MPAA, you may want to negotiate with your employer. It could be possible to reduce pension contributions and receive other tax-efficient benefits or a higher salary.
It’s always worth seeking advice when you are thinking of taking retirement benefits, as there may be ways to achieve your goals without restricting future tax relief.
Please don’t hesitate to contact a member of the team to find out more about retirement planning.
