With the introduction of the pension freedoms in 2015, you can now access tax-free cash from your pension at 55. You can also start to flexibly access your pension with no limits on how much you can take. However, if you plan to flexibly access your pension, you should be aware of the Money Purchase Annual Allowance (MPAA) and understand what it might mean for you and your future retirement savings.
What is the Money Purchase Annual Allowance (MPAA)?
The Money Purchase Annual Allowance MPAA is a limit on the amount you can pay into your pension and still receive tax relief. It is triggered once you start taking an income from your pension.
It limits the value of your pension contributions that can be paid into your pension tax efficiently and applies to money put in by you, your employer or anybody else.
To understand the Money Purchase Annual Allowance you first need to understand how pension tax relief normally works.
How pension tax-relief works
As a UK taxpayer, you normally receive tax relief on anything you pay into your pension at your highest rate of tax, and you don’t pay tax on your employer’s contributions. You currently get tax relief on 100% of your pension contributions at your highest rate of tax and you can put up to £40,000 a year into your pension. (This does get more complicated if you earn over £150,000 a year – as there’s a tapered allowance)
However, if you trigger the Money purchase Annual Allowance, this changes.
Money Purchase Pension aka Defined Contribution Pension
Pensions can be complicated. It’s not helped by the fact that there can be a number of different names to describe the same thing. A money purchase pension is the same as a defined contribution pension – you pay money into your pension pot whilst you’re working and then when you retire you use the money built up in your pension pot to provide an income. – You can buy an annuity (a guaranteed pension for life) or you can use flexi-drawdown to take money out of your pot as and when you need it. You need to make sure there’s enough money in your pot to last you through retirement.
In the 2019/2020 tax year, you can pay up to £40,000 tax into your pension and receive tax relief. However, once you trigger the MPAA your allowance drops to just £4000.
How does the money purchase annual allowance work?
Once you start taking an income from your pension you will trigger the Money Purchase Annual Allowance. It is currently set at £4000 per year. This is the maximum amount you’ll be able to pay into your pension and receive tax relief on.
If you plan to retire early or fund a partial retired/phased retirement by accessing your pension from the age of 55, you’ll need to consider the effect on your retirement planning. You won’t benefit from the same favourable tax-relief as before.
What happens if you exceed the MPAA?
In the first year after you trigger the MPAA it is only the amount paid in after it is triggered that is measured against the MPAA. For every year after that everything you pay in will count towards your annual allowance.
Taking a pension lump sum
You can access your pension at 55 and access up to 25% of it as a tax-free lump sum. If you just take the tax-free cash, you won’t trigger the Money Purchase Annual Allowance and you can continue to pay into your pension tax-efficiently as you did previously, but if you opt to take your pension lump sum in other ways, you could trigger the MPAA.
Read more about taking a pension lump sum here
What Triggers the Money Purchase Annual Allowance?
There are several scenarios where you could trigger the MPAA, for instance, if you:
- Take your whole pension pot as a lump sum or start to take ad-hoc lump sums
- Start taking an income from your pension in a flexi-access drawdown scheme
- Buy an investment-linked or flexible annuity where your income could go down
- Start to take payments that exceed the cap on a pre-2015 capped drawdown plan
What won’t trigger the MPAA
- Taking only tax-free cash from your pension
- Taking Income from a lifetime annuity
- Remaining in capped drawdown – as long as your income payments don’t exceed the limit (see our pension drawdown calculator)
- Small pot withdrawals (on accounts worth less than £10,000)
If you are unsure you should contact a financial adviser or speak to HMRC
Can you carry forward your money purchase annual allowance?
No, unlike your annual pension allowance, which can be carried forward for up to 3 years (under certain circumstances), you cannot carry forward your Money Purchase Annual Allowance.
What to consider if you are impacted by the MPAA
You are responsible for monitoring your MPAA and you’ll need to declare it to HMRC through a self-assessment form. If you exceed your allowance any tax-relief you’ve received will be clawed back.
MPAA also covers any contributions made by your employer, so if you continue to work after taking an income from your pension, you’ll need to monitor any pension contributions your employer makes on your behalf.
If you trigger the Money Purchase Annual Allowance, but still want to save tax efficiently, you could consider paying into an ISA. The current ISA allowance is £20,000 per year.
What if I have a Defined Benefit Pension?
The money purchase annual allowance doesn’t apply to Defined Benefit / Final Salary pensions, so if you have multiple Defined Benefit pensions, you could start to take one whilst still paying into another scheme or you can start taking a Defined Benefit Pension and continue to pay into a Defined Contribution pension without penalty.
However, if you have both and you’re paying into a Defined Benefit pension and you trigger the MPAA on a Defined Contribution Pensions, it could affect your overall annual allowance. If this is the case, you can still pay into your pension using the ‘alternative annual allowance’. This is £36,000 in the 2019/20 tax year.
How we can help?
Our retirement specialists can help you plan your retirement to maximise your money. Whether you plan to retire early or want to continue working and take part of your pension, we’ll help you work out the best way to do it.
Let us take the stress out of retirement planning for you.
