How to take money out of your pension without triggering the MPAA
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.
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”.
A range of events can activate the MPAA rules, but there are eight in particular that tend to be most prevalent.
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.
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.
At Punter Southall, we have a team of highly skilled risk, compliance and legal experts with deep in-house practical experience. Get in tough if you would like a friendly chat with one of us.
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