As new pension drawdown options grow in popularity, earlier this year the Government implemented a change to the limit of how much you can pay into your Money Purchase Pension Scheme, reducing it from £10,000 to £4,000.
There’s a danger of unexpected tax bills as people may have little understanding of the limits, or the consequences of exceeding them.
What is the Annual allowance?
The Annual Allowance (AA) is the maximum that anyone can pay into a pension scheme in each tax year and obtain tax relief. This is currently set at £40,000.
Think of this as the upper limit.
What is the Money Purchase Annual Allowance?
Generally, once a person accesses their pension benefits on a flexible basis, and takes an income from their pension pot, their AA changes to the lower Money Purchase Annual Allowance (MPAA). When it was introduced (at the same time as pension freedoms) in 2015 the MPAA was set at £10,000. This limit has been cut to £4,000 from April 2017, as announced in the Chancellor’s 2016 Autumn Statement.
This affects the type of pension schemes that you can generally draw from age 55, not historic ‘final salary’ schemes. The MPAA is effectively the tax allowable amount you are permitted to pay in to your pension in each tax year.
If you have taken more than your tax free cash, even just £1, then your annual pension allowance will be restricted down by the MPAA for the rest of your life.
Will this apply to me?
By and large, if you are over 55 and have not taken anything from your pension, or only ever taken your Pension Commencement Lump Sum (PCLS), also known as ‘tax-free cash’, then you will not be affected. You will still be able to obtain tax relief on any pension contributions.
Remember: The MPAA is only triggered if you access your pension income. If you haven’t done so, then the AA rules apply, and you can save up to 100% of your earned salary in your pension, capped at a maximum of £40,000 each tax year.
Why is it being reduced?
The chancellor, Philip Hammond, stated that this has come into force “to prevent inappropriate double tax relief”. In other words, preventing people from diverting a significant proportion of their earned income into their pension then withdrawing up to the 25% allowed tax free and/or recycling tax free lump sums back into their pension.
What happens if I go above the MPAA?
The amount that you have gone over will be added to your income for that year and you will be charged income tax accordingly. You should note that the additional income you are being taxed on could push you into a higher income tax bracket.
Can you carry forward the MPAA from previous years?
MPAA is set at £4,000 a year and you are not allowed to carry forward any unused allowances from previous years.
How does the limit apply?
The MPAA includes both your own contributions and any other contribution made on your behalf from your employer into a pension. It should be noted that the limit is per person rather than per scheme. So, it applies across all contributions made in a year.
Important: Before making any income withdrawals or large contributions into your pension provision we strongly recommend seeking independent financial advice.
Accessing pension benefits early may impact on levels of retirement income and is not suitable for everyone. You should seek advice to understand your options at retirement.
Levels and bases of and reliefs from taxation are subject to change and their value depends on the individual circumstances of the investor.
The Financial Conduct Authority does not regulate taxation advice.