Pension freedom, and the fact that we are living longer, have changed how many of us think about retirement. More of us, around a third, are going on working after we have started taking our pensions. Some are even taking a cash lump sum from pension pots to start a business. Keeping active is a great idea – but it could lead to a surprise tax bill.
This problem may arise if we still have an income from our work or business and continue to save into a pension fund after we have taken money out of it.
HMRC believe that some people who are already drawing a pension have been abusing the rules to get tax relief on their pension savings twice.
This could happen when people who have taken a cash lump sum from their pension pot then simply put it back again, earning tax relief each time. Recycling the money would be particularly rewarding for higher rate taxpayers, who in effect would get £1.40 for every £1 they save.
The Government believes this misuse, known as ‘double tax relief’ may be increasing, and are determined to put a stop to it.
Money Purchase Annual Allowance
The annual allowance allows everyone to save up to £40,000 into pensions each year, or a sum equal to their income, whichever is the smaller, before they retire. In theory at least, someone who had continued to work after accessing their pension could withdraw £40,000 from their pension pot each year, and simply pay it back in, enjoying a rewarding 40% bonus each time.
The Money Purchase Annual Allowance (MPAA) was introduced by the Taxation of Pensions Act 2014 to coincide with pension freedoms. It imposed a £10,000 a year annual allowance on over 55s who had drawn down cash from their pension. This meant that once pension pots had been accessed, the maximum that could be paid into them became limited to £10,000 each year.
People in this position, known as ‘taking benefits’ could still contribute £10,000 a year into their pension and enjoy tax relief on these contributions at their highest income tax rate. Now the Chancellor has decided to restrict the double tax relief loophole even more, and cut the MPAA from £10,000 to £4,000 from April 2017.
This could affect hundreds of thousands who have used the new pension freedoms and taken cash from their pension pots.
Who is at risk?
Anyone who has taken money from their pension pot, but is still contributing into a pension may be in a position to be hit by the reduced MPAA, and an unexpected bill from the taxman.
But the position is complicated. Someone taking a 25% tax-free lump sum from their pension could continue to contribute £40,000 per tax year. However, if they took a taxable income from their pension pot they would see their annual allowance drop 90% to £4,000 under the revised MPAA.
There are some ways to avoid the MPAA restriction. If your provider allows it, you might be able to use the ‘small pots’ rule. This allows you to take three separate pots worth less than £10,000 each and retain the full £40,000 allowance.
Basically, if you have already dipped into your pension pot, you may have triggered the money purchase annual allowance. You should probably seek expert advice as soon as possible.
To get a real understanding of the pensions rules, the proposed changes, and what you can do to keep your pension plans on track, please contact our professional team today.
A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available.