1.6 million people fell foul of this little-known tax trap – are you one?

By HarperLees

According to data by the Office for National Statistics (ONS), prior to the coronavirus outbreak almost one in three of Britain’s workforce was aged 50 or above. Nearly three-quarters (72%) of 50 to 64-year-olds were employed with 10% of people aged above 65 still working.

If this demonstrates one thing it’s that “cliff-edge” retirement is over for most. Before the default retirement age was scrapped in 2011, people typically finished work on their 65th birthday and, with carriage clock in hand, embarked on retirement.

Now, research by pension provider Aegon reveals over two-thirds (70%) of those aged 50 and above are likely to reduce their working hours before retiring fully. While it’s difficult to predict the future, it’s likely this will continue to be the case when we return to normal after the pandemic, however that may look.

If you are one of them, a major advantage could be the ability to continue building your pension while earning an income, giving you more time to boost your pot. On the face of it this sounds like a positive, although you need to be aware of a little-known tax rule that 1.6 million people have fallen foul of in the last five years.

Read on to discover what it is and how it works.

Beware of the Money Purchase Annual Allowance (MPAA)

According to research by retirement specialists the Just Group, 260,000 working pensioners were caught out by the little-known MPAA rule in 2020 alone.

Under the MPAA, if you’re taking an income from a money purchase pension – otherwise known as a “defined contribution (DC) pension” – while contributing towards another money purchase scheme, your Annual Allowance reduces significantly.

Your Annual Allowance is the amount of pension contributions you’ll receive tax relief on and is typically 100% of your income up to a maximum £40,000 in the 2021/22 tax year. Under the MPAA rules it could drop to just £4,000.

Your workplace pension may fall under the MPAA rules

The issue you could face is that many workplace pensions are money purchase schemes, thus reducing your Annual Allowance to £4,000. If you have a defined benefit (DB) scheme, otherwise known as a “final salary scheme”, the MPAA shouldn’t affect you.

If you’re not sure which type of pension your workplace scheme is, speak with a financial planner who will confirm.

You could take part of your pension and not fall foul of the MPAA

Typically, if you only take your tax-free lump sum from your pension and not an income, the rules are not triggered. This means you may boost your salary using the tax-free element of your money purchase pension, and not be subject to the MPAA.

If you take an income from your pension and trigger MPAA rules it could mean:

  • You pay Income Tax on pension contributions above £4,000 when under normal Annual Allowance rules, you wouldn’t.
  • You cannot use carry forward, which would have allowed you to use unspent Annual Allowance from the previous three years.
  • Growth in your pension is potentially reduced.

To show the latter point, imagine if you work part-time and earn £20,000 a year and you draw income of £5,000 a year from a defined contribution pension. You and your employer also contribute a total of £8,000 a year to your workplace money purchase pension scheme so that you can enjoy a better standard of living when you finish work.

Typically, these contributions will be liable to the MPAA, meaning you receive tax relief on half of the contributions you make (£4,000). If you pay Income Tax at 20%, you will pay £800 Income Tax on the remaining £4,000, instead of HRMC adding £800 to your pension through tax relief.

As this £800 is not being contributed towards your pension, the size of your pension pot shrinks, and with it your retirement fund’s potential for growth in the future.

Get in touch

If you would like to discuss your pensions and the risk of losing out under the MPAA rules, please get in touch. As this blog reveals, many pensioners have fallen foul of its rules, and we’d be happy to discuss with you whether you may be one of them.

Email us on info@harperlees.co.uk or call on 01277 350560 and we’d be happy to discuss your situation further.

Please note

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. Your pension income could also be affected by the interest rates at the time you take your benefits.