Avoid pension penalty
MONEY PURCHASE ANNUAL ALLOWANCE
OLDER workers who make flexible pension withdrawals risk getting tripped up by the Money Purchase Annual Allowance (MPAA), which shrinks the amount you can contribute in future.
More than half a million over-55s make flexible withdrawals every year, but the MPAA could trigger a shock tax bill and limit future pension contributions for life.
You can get tax relief on pension contributions up to £40,000 a year or 100 per cent of your taxable salary. However, the moment you draw money from a defined contribution pension, the amount you can pay into your pot and claim tax relief on crashes to a maximum of £4,000, with tax penalties if they exceed that sum.
Savers also lose the ability to carry forward unused pension allowances from the previous tax years.the vast majority do not realise the danger, even though one in seven made flexible withdrawals in the last 12 months, of whom more than half continued to contribute to their pension.
Two in five are unaware that this rule exists, while a similar proportion are aware but uncertain about the detail. Many overestimated the MPAA, putting it at almost £7,000 a year, research from pensions specialist Canada Life shows.
The Government introduced the MPAA to stop savers from repeatedly “recycling” their pensions, making withdrawals then
pumping the money back into their pot to claim valuable tax relief.
However, Canada Life technical director Andrew Tully said it penalises older workers who reduce their hours, set up their own business or embark on a less pressured career, while making flexible pension withdrawals to top up the shortfall in their income.
It also hits those who have made withdrawals to cover lost income or meet unexpected costs during the pandemic. He said: “Many who have made taxable withdrawals will need to re-build their savings once the pandemic is over.”
Tully called on the Treasury to restore the MPAA to its original £10,000 limit but added “my preference would be to scrap it altogether”.
Stephen Lowe, group communications director at retirement adviser Just Group, said freezing the MPAA at £4,000 will hit many on the auto-enrolment scheme who are contributing 8 per cent of their salary to a workplace pension.
The higher rate income tax threshold was increased to £50,270 in April, Lowe said: “Someone earning that amount would automatically pay £4,021 into their pension, exceeding the allowance with tax relief clawed back.”
Lowe added that it was unfair to expect people to navigate such a complex system.
The MPAA is triggered if you take your pension as a lump sum, draw ad hoc sums, or shift it into a flexi-access drawdown scheme and take income from that.
There are exemptions if you take a tax-free cash lump sum and use it to buy a lifetime annuity, or put your pension pot into a drawdown scheme but do not take any income from it. Ed Monk, associate director for personal investing at Fidelity International, said: “It does not apply to the 25 per cent of your pension that can be taken as a tax-free withdrawal.”