Many people dream of retiring early, or scaling back their hours (making up the income using pension withdrawals). However, this can trigger a little-known rule that potentially causes big problems for your retirement plan if you are not careful. This is called the MPAA – money purchase annual allowance – and it significantly lowers how much you can keep putting into your pension. Below, our financial planning team at Vesta Wealth explains how the MPAA works, how it can impact a financial plan and how to avoid the issues it can cause.
What is the money purchase annual allowance?
In 2022-23, you can usually put up to £40,000 into your pensions each tax year – or, up to 100% of your salary (whichever is lower). This is called your “annual allowance” and it offers some very generous benefits to help grow your retirement fund.
In particular, tax relief is offered by the UK government on any contributions you make within your annual allowance. In effect, this takes the income tax you would have paid on your contributions and, instead, puts this into your pension. So, a Basic Rate taxpayer gets 20% relief – meaning it only “costs” him/her 80p to put £1 into their pension pot. For someone on the Higher Rate, the cost is only 60p (40% relief).
Naturally, you should take advantage of these rules as much as you can during your career – to get the most “free money” you can from the government, and benefit from compound growth on your contributions over the years.
The MPAA concerns how much you can keep contributing to your pension(s) after taking taxable benefits from them. If you trigger the MPAA rules, instead of being able to save up to £40,000 into your pension, your annual allowance is reduced to £4,000 – potentially a 90% reduction. This was introduced with the Pension Freedom reforms in 2015 to try and stop people from abusing the new pension system (i.e. to avoid tax).
How can the MPAA affect a financial plan?
Many people activate the MPAA rules inadvertently due to the complex pension system in the UK. However, once they are triggered they are set in place – you cannot go back to your old annual allowance. Here is a (non-exhaustive) list of possible MPAA triggers:
- Uncrystallised Funds Pension Lump Sum (UFPLS). Here, the rules can be triggered by taking pension benefits without going into drawdown or buying a lifetime annuity.
- Flexi-access Drawdown Income. Although specifying pension funds for flexi-access drawdown is not a MPAA trigger, taking income or lump sums from these designated funds is a trigger.
- Overseas pension payments. If you work abroad, then receiving a payment from an overseas scheme (e.g. a QROPS) can activate the MPAA rules.
- Flexible Annuity. If you are entitled to an annuity after 6 April 2015 – and it is not allowed by SI2006/568 – then the MPAA rules are activated.
The MPAA rules can be a big problem if you want to keep building up your pension before fully retiring. Since you will be limited to only contributing £4,000 per year, you may be forced to consider other tools such as an ISA (which offers tax-free investment growth, but no tax relief from the government; any salary which you put into your ISA will be taxed first). In worst-case scenarios, the MPAA rules may force you to work longer or lower your retirement lifestyle goals.
How do I avoid the MPAA trap?
Most people are likely to trigger the MPAA rules, eventually, as they retire. However, it is crucial to not activate them before you are ready. To avoid problems, make sure you avoid taking any income or lump sums from pensions until you have spoken with a financial adviser. This person will understand the complex tax landscape and pension rules, offering insight and advice which can help you make informed decisions.
Be careful not to assume that you can simply reduce your paid working hours and start taking money from pensions, without consequence. It may be that this is perfectly achievable given your financial position and goals. However, many people might not be able to afford accessing their pension early. Bear in mind that average UK life expectancy is 81, so if you partially retire at age 57 you may need your pension fund(s) to last 24 years or even longer (each year, there are about 15,120 centenarians!).
There is good news for some. Those receiving a scheme pension from any defined benefit (or “final salary”) pension will not trigger the MPAA. Also, you can access “small” pension pots from age 55 (rising to 57) if they are “non-occupational” and under £10,000 in value. 25% will be free from tax, with the rest subject to your marginal rate of income tax. Taking a “non-flexible” annuity also usually does not act as a trigger.
Invitation
If you would like to discuss your financial plan and retirement strategy, then we would love to hear from you. Get in touch with your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.
Reach us via:
t: 01228 210 137
e: [email protected]
This content is for information purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice regarding your affairs please consult your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.