How to avoid the Money Purchase Annual Allowance “tax trap” on your pension savings
Retirement is your opportunity to do the things that you love, and starting earlier gives you more time to make the most out of it. A partial transition into retirement is an excellent way to begin this exciting new chapter of your life sooner rather than later.
A new study from Aviva shows 2 in 5 people aged 55 to 64 plan to move into semi-retirement before they reach State Pension Age, meaning they intend to continue working part-time, while also drawing from their pension.
This can be a good way to gain more freedom while also remaining part of the workforce and continuing to contribute to your retirement.
If you are working part-time, or in a consultancy role, it may benefit you to continue making pension contributions. You will likely benefit from tax relief on your contributions and your employer may also be paying into your fund.
However, if you’re also drawing flexibly from your personal pension, it could mean that you are affected by the Money Purchase Annual Allowance (MPAA).
Research from Canada Life found that just 4% of over-55’s know exactly how the MPAA works and only 62% have heard of it at all.
This is concerning, especially as the 2023 Budget introduced changes to encourage more people to continue working in later life, meaning they may be affected by the MPAA.
Read on to learn what the MPAA is, how it works, and whether you are likely to be affected.
The MPAA is designed to limit “pension recycling”
The MPAA was first introduced in 2015 to limit “pension recycling” meaning that, if you take cash from a defined contribution (DC) pension pot, you could then re-invest it in your pension and receive tax relief a second time. That’s where the MPAA comes in.
Once you start drawing money flexibly from your DC personal pension, the MPAA will usually be triggered and the annual amount you can contribute to your pension and receive tax relief on will reduce.
Ordinarily, your Annual Allowance is £60,000 – previously £40,000 prior to 6 April 2023 – meaning that you can accrue a total of £60,000 in your pension pot each year without tax charges. But once the MPAA is triggered, this will reduce to £10,000.
The MPAA may be triggered if you:
- Take all or part of your DC pension pot as a lump sum (though there are different rules for small pots)
- Move your pension pot into a flexi-access drawdown and take income from it
- Buy an investment-linked or flexible annuity.
However, the MPAA is not usually triggered if you:
- Take a tax-free lump sum and use it to buy a lifetime annuity that provides an income that will not decrease
- Move your pension pot into a flexi-access drawdown but you do not take income from it.
Additionally, if you cash in small pension pots worth less than £10,000, they may be subject to small pot pension rules. In some cases, this means you may be able to avoid triggering the MPAA.
However, each case is unique, and it may be beneficial to speak to a financial planner to determine whether you will trigger the MPAA or not.
The MPAA was increased to £10,000 from 6 April 2023
As the study from Aviva showed, a significant number of people are considering semi-retirement, and this means they may be affected by the MPAA. Additionally, changes to the MPAA made in the 2023 Budget aimed to encourage more people to “unretire” and return to work.
In the 2022/23 tax year, the MPAA was set at £4,000. However, in the spring Budget, the chancellor increased the MPAA to £10,000 from 6 April to encourage more people to remain in the workforce or return to work after retiring.
This is positive news if you plan to work while also flexibly drawing money from your pension as it means you may be able to pay more back into your pension pot while receiving tax relief.
However, if you decide to continue working in later life, the chances of you being affected by the MPAA are greater. So, it is crucial that you understand when it is triggered and what the potential tax implications are.
Get in touch
If you are concerned about the MPAA and how it may affect your retirement planning, we can give you guidance.
Email email@example.com or call 01905 419890.
This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future results.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts.