Financial planning

MPAA - one to watch out for

Colin Dyer

Plans to cut the Money Purchase Annual Allowance (MPAA) were first revealed last November, in the 2016 Autumn Statement. Since then it’s been a bit of a “will they, won’t they” situation, as the planned cut was dropped from the Finance Bill ahead of the 2017 general election. Now the government has confirmed that they intend to press ahead with the change, and most importantly, the lower limit will be backdated to the start of this tax year, so from 6 April 2017.

 

The MPAA is a little-known rule which only affects a handful of savers. The reduction in what you can pay in only applies if you have already started drawing an income from your pension. For many people, the first time they dip into their pensions will be the day they stop work. So a drop in their annual allowance is of no significance as they are no longer paying in to their pension.

But if people are caught unaware they risk being surprised by a tax charge, so it’s definitely an allowance worth watching out for. Read on and I’ll explain how it works, who will be affected and what you can do to deal with it.

What is the Money Purchase Annual Allowance?

Since pension freedoms in 2015, over-55s have had pretty much unlimited access to their pension pots; being able to withdraw what they want, when they want. But once you start taking money (over and above tax-free cash) you trigger the MPAA which restricts how much you can then continue to pay into your pension. It used to be set at £10,000, but the latest announcements mean that this is to be cut to £4,000.

The MPAA is designed to stop people ‘recycling tax relief’ by taking money out their pension and putting it straight back in again, effectively claiming tax relief twice. Normally you can deposit up to £40,000 into your pension each year, depending on your income (this is known as the Annual Allowance). But if you trigger the MPAA you’re stuck with the lower figure.

The other thing to be aware of is that you can’t ‘carry-forward’ your Money Purchase Annual Allowance, so you’ll be limited to £4,000 a year regardless of whether you used your allowance the year before or not. Unlike the Annual Allowance, it really is a case of use it, or lose it.

But what happens if you do go over your allowance? This part’s fairly simple: If you put more than £4,000 into your pension after triggering the MPAA you’ll face a tax charge on the excess. This will be charged at your highest marginal rate, so could be up to 45%.

Who will be affected?

The MPPAA only affects you if you have a defined contribution pension and you have started to take an income but are still paying into your pension. You won’t be affected by the £4,000 limit if you only take tax-free cash out of your pension, without drawing an income.

This is quite an unusual set of circumstances – drawing your pension yet still paying in to it – people more likely to find themselves in that position will typically have plans to phase their retirement, or might’ve used pension savings to fund a break in between jobs.

If you think you may need to take cash out of your pension in the future, but intend to carry on funding at a later date, the main way to avoid triggering the MPAA is to just take tax free cash. You have to make sure that your pension scheme allows this though, as some older schemes may not offer that flexibility. If that’s the case you may want to consider consolidating or transferring your funds to give yourself the freedom you require. Talk to your financial planner first though, as transferring pensions isn’t always a good idea, particularly if there are guaranteed benefits that might be lost.

The MPAA doesn’t affect all pensions

The MPAA only affects pensions which can be freely accessed thanks to pension freedoms; like a SIPP, for example. You might also have other types of pension, such as a Defined Benefit scheme, which do not offer the pension freedoms.

Another loophole in the MPAA is that cashing in small pots won’t trigger it. This is under the ‘triviality’ or ‘stranded pots’ rules and means that if you have pensions pots worth less than £10,000 you can access your money without worrying about the MPAA.

Triggering the MPAA

The main difficulty with the MPAA is that most people don’t even know it exists, and if they do, they’re not sure what triggers it. This is where having a financial planner gives you a strong advantage.

Basically, if you withdraw any income from your pension you’re likely to trigger the MPAA. Tax free cash doesn’t count because it’s not regarded as an ‘income’, so you can access 25% of your pension pot without having to worry.

However, it’s not actually quite as simple as that. There are lots of little rules regarding what counts as a trigger event. For example, taking a secure income (such as a non-flexible annuity) doesn’t count, whereas a flexible annuity could.

That’s just one scenario though, and there are several other nuances that can have an impact. If you speak to your financial planner before withdrawing anything from your pension, they’ll be able to keep you right as to whether you’re at risk of triggering the MPAA.

One thing to remember is that it’s only contributions made after the trigger event that count towards your allowance. So if you’ve already paid £5,000 (for example) into your pension this tax year, and then decide to make a withdrawal that triggers the MPAA, you could still deposit a further £4,000 in before the end of the year. The moral of this story is that if you’re planning on accessing your pension soon, it could be a smart move to maximise funding before you trigger the MPAA.

What to watch out for

The first step to avoiding any nasty tax surprises is being aware. We’ve spoken to people who have heard of the MPAA but didn’t realise their actions would trigger it. One gentleman had a small pot worth around £13,000 which he thought he would cash in completely as it would tidy-up his retirement savings – unfortunately this action means he is now subject to the MPAA and has severely restricted how much he can contribute to his remaining pensions.

In today’s world, the MPAA can make things especially tricky because retirement is not as straightforward as it used to be. Traditionally people stopped working completely when they decided to retire, however, there is a growing number of over-55s who take early retirement from their main job to work part-time or set up their own business. Often they’ll use retirement savings to subsidise a reduction in earnings – but doing this may bring the MPAA your way, which makes partial retirement more difficult.

We understand that ‘retirement’ means something different to everyone these days, so whatever your plans are, it can help to work it out with a financial planner to make sure your strategy is as tax-efficient as possible; effectively helping your savings to fund your life for longer.

Get in touch

If you’re worried about the MPAA, speak to your financial planner – they’ll be happy to help. Alternatively you can leave a question for me below.

If you don’t yet have a financial planner, you can book an initial meeting with us to discuss your concerns and see how we could help you. Just contact your nearest office to find a time that suits you.

 

This blog should not be regarded as financial advice. Laws and tax rules may change in the future and your tax treatment is based on your individual circumstances. The information here is based on our understanding in August 2017. Investments can go down as well as up in value and you may get back less than you pay in.