Restrictions on Pension Savings
A pension rule not much known about which affected some advice I gave a few weeks ago caused me to think it might be worthwhile to explain it here.
Most pension investors are aware that you may save up to £40,000 per year into your pension. Many investors will also be aware that having used up your annual allowance, you may carry forward used allowances for up to the three previous tax years. And, all high earners will be aware of the “tapered annual allowance” which means that, with effect from April 2016, earnings above £150,000 per year cause the annual allowance to reduce by £1 for every £2 of annual earnings over £150,000, with the reduction capped to £30,000.
But there is one other restriction that may catch you unaware, particularly if you have a small pension which you are thinking of encashing completely while continuing to save into your main pension. I am referring to the “Money Purchase Annual Allowance”.
This little known rule is an anti-abuse feature designed to prevent pension investors from withdrawing money from a pension only to recycle it into a second pension plan and thereby gain yet another dose of income tax relief on the contribution. The rule came into effect from April 2015 and was tightened further with effect from April 2017.
The rule states that if you encash a pension in whole, no matter how small, or take a tax-free cash payment followed by an income withdrawal, the MPAA will be triggered and thereafter you will be restricted to a reduced pension savings limit of £4,000 per year. Worse still, after triggering the MPAA, you will no longer be able to use the carry back allowance.
Anyone with an old style “Capped Drawdown” pension will be unaffected by the MPAA rule.