Royal London has flagged the need to carefully manage pension pot withdrawals if clients are to benefit from an exception to the Money Purchase Annual Allowance (MPAA) rule, which limits pension payments to £4,000 once pension holders have started drawing taxable cash.
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, known as the Money Purchase Annual Allowance (MPAA), 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, the mutual insurer says, those who take everything out of a ‘trivially’ small pension pot under £10,000 do not trigger the MPAA.
Hence, 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.
Royal London uses as the example of someone with two pension pots, one worth £4,000 and one worth £20,000, who wants 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.
Steve Webb, director of Policy at Royal London comments: “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.”
