How to take money out of your pension without triggering the MPAA
Withdrawing money from a pension
Have you ever considered “dipping into” your pension to plug a fall in your income?
One study shows that, in 2020, about 5,000 people per week did this - but triggered (likely unwittingly) the Money Purchase Annual Allowance (MPAA) rules in the process. This can have disastrous consequences for someone’s retirement savings, since it effectively reduces the tax-relieved amount you can contribute into a pension each year by up to 90%. We want to help inform and protect people from making this mistake. In this article, we explain how the rules work and explain some ideas for navigating them effectively, so you don't fall into the Money Purchase Annual Allowance trap.
How the MPAA works
Most UK residents are allowed to contribute up to £40,000 per year tax-free into their pension scheme(s) - or up to 100% of yearly earnings (whichever is lower). This is called the “annual allowance” and it provides a strong level of flexibility for the majority of pension savers, who can also make use of unused allowance from the previous 3 tax years.
These limits are in place mainly to stop wealthier people from amassing “pension fortunes”, due to the attractive tax reliefs pensions offer. Currently, a Basic-rate taxpayer only needs to put 80p into his/her pension to contribute £1 (20% tax relief), whilst someone on the Higher-rate need only put in 60p (40% relief). However, the UK government also wants to limit people from gaining unfair advantage from the tax system - i.e. by drawing from a pension whilst also continuing to work (and potentially still, contributing into a pension). This is where the MPAA rules come into play - brought in with the 2015 Pension Freedoms.
When triggered, these rules reduce your annual allowance to £4,000 - lowering the amount you can contribute to a pension and earn tax relief. Once activated, the MPAA cannot be undone in an individual’s case. So, it is crucial to make sure that you only trigger it when you are ready. Frustratingly, however, the rules can be complex and difficult to understand - making it easy for unwary individuals to fall into an “MPAA trap”.
Common MPAA triggers
A range of events can activate the MPAA rules, but there are eight in particular that tend to be most prevalent.
- The first involves drawing an income from a “flexi-access drawdown” (FAD) pension. In simple terms, this involves taking bits of your pension as income (when needed) and keeping the rest invested.
- The second is when you take an income from a flexible annuity (a financial product which generates a guaranteed income in retirement).
Many of the other triggers start to get more complicated, which is partly why they are activated inadvertently.
- The third is when you take a lump sum via an “uncrystallised funds pension lump sum” (UFPLS). This relates to your lifetime allowance (outlined above). When you take a pension benefit, your pension becomes “crystallised” to measure its value. This is then deducted from your lifetime allowance to determine how much of it you have left.
- The fourth refers to a specific case where one type of pension (called a “capped drawdown” scheme) is converted to a “flexi-access drawdown” scheme (the FAD scheme, mentioned earlier).
- The fifth trigger relates to this, where a person takes out more from a capped drawdown scheme than the maximum permitted.
The remaining three triggers are also quite specific.
- The sixth trigger happens if you were a member of a “flexible drawdown” plan prior to April 2015.
- The seventh occurs when you receive a pension income from a “final salary” scheme which has fewer than 12 members.
- The eighth and final trigger is very specific indeed. This activates when you (as a scheme member) receive a stand-alone lump sum, where the rights (after the 6th April 2006) exceed £375,000 and where you have “primary protection”.
Navigating the MPAA
As you can see, these scenarios are difficult for most people to know intuitively. Many people simply want to start taking some of their pension income after the age of 55, to supplement their employment income (perhaps as they slowly wind down their hours). This can be a good option for some people, provided they have first understood the MPAA rules.
So, how can you ensure that you don’t trigger the MPAA by accident?
It is always best to seek financial advice for absolute peace of mind. However, a good principle is to not exceed your 25% tax-free lump sum withdrawal after the age of 55. For instance, if you have a £500,000 pension pot then you could withdraw £125,000 usually without fear of triggering the MPAA.
Another idea could be to cash in pension pots each valued under £10,000 (although a limit of 3 non-occupational plans applies). In many cases, it is a good idea to consolidate multiple pensions for ease of management. Finally, remember that the MPAA rules only apply to pension schemes involving a “pot” of money. The rules are not triggered if you start accessing benefits from a final salary pension (or defined benefit) scheme from the age of 55.