Annual Pension Allowance

Everything You Need to Know About Your Money Purchase Annual Allowance (MPAA)

Have you ever wondered what MPAA stands for & why you need to pay attention to that term? Well, if you’re looking to retire soon, or have a pension fund, it’s a good idea to read on!
Annual Pension Allowance

The MPAA (money purchase annual allowance) limits the amount of money that you can deposit into your pension without paying tax. This is only once you’ve started gaining an income from your pension. For the financial year 2020/21, the MPPA is £4,000.

An Explanation of the Money Purchase Annual Allowance

An MPAA is a yearly cap on the amount of money you can put into your pension in any given tax year. It applies to those that have opted for what’s known as “money purchase” pensions

What does this mean for you:

This means that each contribution counts towards your MPAA limit, not just contributions made from income earned witin the tax year.

This allowance applies to those with defined contribution pensions, but not where a final salary scheme exists – this is because there are provisions in place that make it difficult for an employer and employee to predict what they will need from their pension  

What does the MPAA Mean for Your Pension

What does the MPAA Mean for Your Pension?

Here’s an interesting fact:

The money purchase annual allowance has been part of the Pension Freedoms since 2015. It determines the amount of tax relief you can receive. Tax relief is usually granted on pay-ins you make after you’ve withdrawn from your pension. However, money purchase restrictions are only for contributions made to a defined contribution pension. It doesn’t apply to any defined benefit pensions.

Whenever you put cash into your pension, the government should give you tax relief on your contributions.

In the beginning, the money purchase pension contribution limit was set at £10,000. That has been reduced dramatically. Recently, the MPAA is now set at £4,000.

Money Purchase Annual Allowance (MPAA) – Watch Out for the Pension Tax Trap!

The MPAA (Money Purchase Annual Allowance) is the amount that you are allowed to contribute each year towards your pension. The problem is, because it’s a money purchase pension, any contribution counts toward this limit – not just contributions made from income earned within the tax year.

Let’s dig a little deeper:

This means if you have already contributed £30k before April 2017 and then make another £20k worth of contributions throughout May-December 2017, these will be counted against your annual allowance because they were all made during the same financial period irrespective of when they’re paid into your annuity account .

This leads to many people paying an avoidable tax charge.

To be safe, you should check with your pension provider what the limit is and try not to exceed this amount.

MPAA in a Nutshell

MPAA in a Nutshell

The moment you start to withdraw cash from your pension to act as an income, the MPAA is triggered. And only from 55 or up.

The MPAA is only triggered in certain circumstances like when you:

  • Cash in your pension pot entirely and as a lump sum (this could happen in either one or ad-hoc segments)
  • Put your pension into Flexi-access drawdown and start to draw an income
  • Buy a flexible annuity
  •  Withdrawal more than your ‘capped drawdown’ plan

Usually, you won’t have to think about the MPAA pension limits if you:

  • Cash in only a lump sum which doesn’t exceed the 25% tax-free limit
  • Buy a lifetime annuity with your pension funds
  • Cash in a pension pot which is less than £10,000

When you go above the money purchase pension plan contribution limits, you will be taxed according to your marginal income tax rate. Usually, when you pay into your pension pot, you can use the forward carry rule. This rule allows you to claim unpaid tax relief from the previous three tax years. Unfortunately, if you are under the MPAA, you won’t be able to carry forward any annual allowance.

Keep in mind: the £4,000 MPAA won’t be active until you start cashing in the part of your pension that can be taxed. If so, you’ll be limited to the £40,000yearly contribution.

Avoiding the MPAA Tax Charge

The MPAA tax charge is calculated as the difference between your annual allowance and any contributions you have made.

Let me explain:

If this value exceeds £30,000 (for example if you’ve contributed £32,800 worth of pension savings), then HMRC will apply a 55% tax rate on the excess amount so that it falls within the limit. This means an additional £11,400 would be added to your income for 2018/19 (£31k x 0.55)

To avoid paying this unnecessary charges, make sure your total contribution does not exceed 30x£110=£3300 in one year .

Common Questions

What's the MPAA allowance?

What Triggers Money Purchase Annual Allowance?

What Happens If You Exceed The Money Purchase Annual Allowance?

Does Small Pots Trigger MPAA?

Conclusively

The MPAA  isn’t so tricky after all. Just know when it’ll apply to you and when it won’t.

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