A recent article by the BBC makes for interesting reading. It reveals that, in the UK, the number of over-65s who were still working doubled between 1993 and 2018. It echoes research by pension provider abrdn, that shows 66% of people who intend to retire in 2022 hope to continue working in some capacity.
The statistic highlights how retirement has changed over the years. Gone are the days when people left work at State Pension Age to settle into a full-time life of leisure.
Thanks to the Pension Freedoms Act of 2015, which provides more flexibility on how retirees access their pensions, many of those above State Pension Age continue to work either full- or part-time.
While the soaring cost of living might be behind some people’s desire to work, there are plenty of retirees who want to work to remain physically and mentally active.
If you intend to carry on working in retirement, you need to be aware of a little-known and potentially painful tax trap called the “Money Purchase Annual Allowance” (MPAA). Read on to discover why.
The MPAA typically affects people with “money purchase” pensions
The MPAA could affect you if you have a “money purchase” pension, which is also known as a “defined contribution” (DC) pension. While you may think this means it only applies to personal pensions, it’s worth remembering that many workplace pensions are now money purchase schemes.
That’s why it’s important to speak to a financial planner who can confirm whether your scheme is one of them, or a defined benefit (DB) pension. If it’s the latter, which are also called “final salary” schemes, it is usually not liable to the MPAA.
With that in mind, let’s look at how the MPAA is triggered and what it could mean for your retirement.
The value of your pension pot could be significantly reduced
The MPAA is triggered if you decide to flexibly access your money purchase pension – for example, by drawing a flexible income – while still working. If it is triggered, the amount of pension contributions that receive tax relief could drop.
While you can contribute any amount of money to your pension, the level of tax relief your contributions receive is typically limited to the Annual Allowance. In 2022/23 this is £40,000 or the amount you earn, whichever is the lower.
If the MPAA rules are triggered, your Annual Allowance drops to just £4,000. This means any contributions made to your pension that exceed this amount will not receive tax relief.
Because of this, you may be liable to an Income Tax charge on contributions when under normal Annual Allowance rules you wouldn’t. Additionally, the growth potential of your pension pot could reduce.
According to research carried out by retirement specialists Just Group, the MPAA caught 1.6 million retired people out between 2015 and 2020. Furthermore, 260,000 pensioners triggered the MPAA in 2020 alone, resulting in them facing an unexpected tax liability and potentially smaller pension pot.
To demonstrate this, consider the following scenario: A worker earns £20,000 per annum while taking an income of £5,000 a year from their money purchase pension. They, together with their employer, also contribute a total of £8,000 a year to the company’s money purchase workplace pension scheme.
Typically, the contributions will be subject to the MPAA, meaning the worker receives tax relief on half of the contributions made (£4,000). As they are a basic-rate taxpayer they will pay 20% Income Tax, so will have to pay £800 to HM Revenue & Customs instead of the amount being added to the worker’s pension through tax relief.
If the worker had not started drawing from their pension, all £8,000 of their annual contributions would be eligible for tax relief at their marginal rate of Income Tax.
You may be able to take some of your pension and avoid the MPAA
It’s not all bad news though, as you may be able to take a tax-free income from your pension without triggering the MPAA. Typically, you do not trigger the MPAA if you take your tax-free lump sum from your pension without drawing any income.
By boosting your income using the tax-free lump sum alone, you are likely to retain your full Annual Allowance, meaning your pension contributions continue to receive higher levels of tax relief. This could mean your pension continues to get a significant boost from the government.
Get in touch
If you would like to discuss your pension strategy, whether you might be affected by the MPAA and any action you could take to mitigate it, please contact us on hello@ardentuk.com or call 01904 655 330.
As an award-winning financial advice company that was a 2022 VouchedFor Top Rated firm, you can have peace of mind that you will receive excellent advice and the highest quality service.
Please note
This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
