Little known tax rules mean that savers could see their ability to save into a pension slashed by up to 90% if they draw money from the ‘wrong’ pension pot, according to new analysis by mutual insurer Royal London.
Since the introduction of ‘pension freedoms’ in April 2015, savers aged 55 or above have been able to take money out of their pensions in ‘chunks’ rather than turn the whole pension pot into an income for life by buying an annuity. To prevent people from repeatedly taking money out, benefiting from tax free cash, and putting money back in again with the benefit of tax relief, HMRC introduced a limit on the amount people could put back in to pensions once they had started drawing taxable cash.
This limit is known as the Money Purchase Annual Allowance (MPAA) and was originally set at £10,000 per year, but has since been cut to £4,000 per year. This compares with the standard annual allowance of £40,000.
In general, someone taking money out of a ‘pot of money’ or ‘Defined Contribution’ pension is affected by the MPAA if they draw money out beyond the 25% tax-free lump sum.
But there is a little known exception to this rule. Those who take everything out of a ‘trivially’ small pension pot under £10,000 do *not* trigger the MPAA.
If an individual has two pensions and wants to withdraw less than £10,000, they should think seriously about cashing in a small pot in full rather than taking a partial withdrawal from a larger pot, as this avoids triggering the MPAA. As a result, they retain the ability to put up to £40,000 into a pension each year in future, rather than having this slashed to £4,000.
Consider, for example, someone with two pension pots, one worth £4,000 and one worth £20,000. Suppose that they want to withdraw £9,000 (before tax). If they cash in the £4,000 pot in full and take just the 25% tax free lump sum out of the larger pot, they will not trigger the MPAA. But if they take the full £9,000 from the larger pot they will trigger the MPAA which will reduce by 90% their annual allowance going forward.
Commenting, Steve Webb, Director of Policy at Royal London said:
“Last year, over half a million people aged 55 or over made flexible withdrawals from their pension, and many of these withdrawals will have been for amounts under £10,000. If they emptied out a small pot then this will have had no impact on their future ability to save into a pension. But if, by mistake, they took the same amount as a partial withdrawal from a bigger pot, they risk triggering stringent HMRC limits on future pension saving. Those with more than one pension pot should consider very carefully the order in which they access these funds, especially if they may want to contribute into a pension in future”.
Notes to Editors
1. Statistics on flexible withdrawals from pensions can be found at: https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/821141/Pension_Flexibility_Stats_July_2019.xlsx
2. Rules on triggering the Money Purchase Annual Allowance (MPAA) can be found here: https://www.moneyadviceservice.org.uk/en/articles/money-purchase-annual-allowance. This confirms that “[T]he MPAA won’t normally be triggered if… you cash in small pension pots valued at less than £10,000”.
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About Royal London:
Royal London is the largest mutual life insurance, pensions and investment company in the UK, with assets under management of £138.9 billion, 8.6 million policies in force and 4,126 employees. Figures quoted are as at 31 December 2019.