If you’re considering accessing your retirement savings to help make ends meet, bear in mind that doing so may limit the amount you can pay into your pension in the future.
Under current pension rules, you can pay up to £40,000 a year into your defined contribution pension, known as your Annual Allowance. However, once you’ve started taking money out of your pension, this Annual Allowance falls from £40,000 to £4,000 and becomes known as the Money Purchase Annual Allowance (MPAA). You will still receive tax relief on any new top up savings up to the £4,000 limit. Learn more about how the various pension allowances work in our article Understanding your pension allowances.
The MPAA was introduced to stop people from taking money out of their pension, and then recycling the same money back into their pension to benefit from the upfront tax relief. Additionally, it can also have a significant impact on those who’ve been forced to access their pension savings early – perhaps because their income has fallen as a result of coronavirus – as it can limit their ability to save into their pension pot once their income recovers. Find out more about the implications of taking money out of your pension in our article Should I use my pension to boost my income during the pandemic?
The good news is that if you take a 25% tax-free lump sum out of your pension but not any additional income, you can still hang onto your full £40,000 Annual Allowance.
What triggers the Money Purchase Annual Allowance?
The MPAA will be triggered if you move your pension pot into flexible-access drawdown and start to withdraw taxable income. Drawdown enables you to leave your pension savings invested once you retire, and draw an income from them when required. It’s worth remembering that you’re also free to take a 25% tax-free lump sum out if you want to and this will not trigger a reduction in your annual allowance.
You can only use drawdown if you have a defined contribution pension, where the amount you receive at retirement is linked to how much you (and your employer if it’s a company scheme) have paid in, where your pension savings have been invested, and how these investments have performed. Find out more about drawdown in our article How pension drawdown works.
The MPAA will be automatically triggered if you take a lump sum from your defined contribution pension, known as a UFPLS, or Uncrystallised Funds Pension Lump Sum. The first 25% of this lump sum is tax-free, whilst the remaining 75% is taxed as ordinary income. If you use UFPLS to take money out of your pension, you can’t just take the tax-free cash – you must take a taxable element with it, which is what triggers the MPAA.
If you have a final salary or defined benefit pension, the income you’ll receive is based on how many years you’ve belonged to the scheme and a proportion of your final year’s pay. If you receive a pension from any defined benefit arrangement this will not trigger the MPAA, as the MPAA only applies to people taking money out of a money purchase, or defined contribution pension.
What dates will the Money Purchase Annual Allowance apply?
The MPAA runs on a tax year basis and will kick in from the first date you take a flexible income from your pension. For example, if you took a flexible income on July 26 2021, contributions of up to £4,000 could be paid in between this date and 5 April 2022 before a tax charge is potentially payable. In the next tax year, you can only make contributions of £4,000 from 6 April 2022 to 5 April 2023 without incurring a tax charge.
Contributions made before the MPAA has been triggered are ignored for MPAA purposes, so if you’d paid in £5,000 prior to July 26, this wouldn’t be measured against the MPAA and you could still pay in an additional £4,000 between 26 July 2021 and the end of the tax year on 5 April 2022.
What happens if I exceed the Money Purchase Annual Allowance?
If you’ve triggered the MPAA by taking an income from your pension, and then pay in more than £4,000 into your retirement savings, you will usually face a tax charge. This will typically be equivalent to the amount of tax relief you would have benefited from, but working out exactly what you owe can be complicated, so it’s worth seeking professional help if you need help crunching the numbers (see below for where to get advice).
You can also use the government’s pension annual allowance calculator to check if you have an annual allowance tax charge on your pension savings.
Bear in mind that unlike with standard Annual Allowances, you can’t carry forward unused allowances from previous tax years to reduce the amount you’ve gone above the MPAA by.
How do I pay the tax charge?
If you’ve gone over the MPAA and owe tax as a result, you’ll need to complete a tax return and pay the money you owe. In some cases, you might be able to ask your pension scheme provider to pay the charge on your behalf from your benefits but this will reduce your retirement savings.
If you have any other defined contribution pensions, you’ll also proactively need to let the providers know that you’ve triggered the MPAA allowance. You may have to pay a fine if you don’t notify HMRC or providers of other pensions you have.
Accessing your pension
Bear in mind that you can’t touch any money in your pension, including any tax relief on your contributions, until you reach the age of 55, rising to 57 by 2028.
It’s also worth remembering that pension tax rates and benefits can change and are dependent on your personal circumstances, so there are no guarantees that current rules will continue to apply in the future.
For example, there is speculation that the Chancellor could make changes to the MPAA in the Budget on March 3, given that many people may have been forced to dip into their pensions sooner than they wanted to as a result of the pandemic.
Jon Greer, retirement policy expert at financial planners Quilter, said: “The Chancellor could announce in the Budget that he will waive the MPAA triggers so that someone taking pension income flexibly this tax year would retain the normal £40,000 Annual Allowance. In addition, the government could restore the MPAA back to the pre-2017 level of £10,000 per annum. This would alleviate the risk of hitting the MPAA for most people with earnings of less than £100,000.”
If you’re not sure about what to do with your pension, or if you think you might have exceeded the MPAA, it may be a good idea to seek professional independent financial advice. You can find a local financial advisor on VouchedFor or Unbiased.co.uk, or for more information, check out our guides on How to find the right financial advisor for you or How to get advice on your pension.
If you think you might be interested in speaking with a financial advisor, VouchedFor is currently offering Rest Less members a free pension check with a local well-rated financial advisor. There’s no obligation, but once you’ve had your check, the advisor will discuss the potential for an ongoing paid relationship if you think it might be useful to you.
Have you triggered the Money Purchase Annual Allowance by taking a flexible income or lump sum out of your pension? Does it worry you that your future contributions will be limited? We’d be interested to hear from you. You can join the money conversation on the Rest Less community or leave a comment below.