Demistyfing the Money Purchase Annual Allowance

by Simon Alexander | Apr 20, 2023

Introduction to the Money Purchase Annual Allowance

Planning for retirement can be a daunting task, especially with the ever-changing rules and regulations surrounding pensions. The Money Purchase Annual Allowance is one such rule that can have a significant impact on your pension savings.

In simple terms, the Money Purchase Annual Allowance is the amount of money you can contribute to your pension each year, after you have taken a certain amount of benefits from your pension scheme. This article will take you through everything you need to know about the MPAA and how it can impact your retirement planning.

What is the Money Purchase Annual Allowance?

The MPAA was first introduced in April 2015 as part of the UK government’s pension reforms. It was designed to prevent people from using the flexible pension rules to exploit the tax relief system and build up large pension pots in a short space of time.

The current MPAA limit is £10,000 (gross) per year. This means that once you have triggered your MPAA, you will only be able to contribute up to £10,000 to your pension scheme each year. This is significantly lower than the standard pension annual allowance, which is currently set at £60,000 per year.

Here is an illustration of the MPAA (alongside the standard pension annual allowance) since the 2016/17 tax year:

The MPAA applies to people who have already accessed their pension savings flexibly and limits the amount they can contribute to their pension scheme each year without incurring additional tax charges.

While the MPAA may be seen as a restriction on pension saving, it is important to remember that it was introduced to ensure that the tax relief system is not exploited, and that people are not able to build up large pension pots too quickly by gaining tax relief twice – withdrawing pension income and then paying the income straight back into the pension.

When does the MPAA apply?

The MPAA comes into effect when you start taking money ‘flexibly’ from your pension scheme. Flexibly accessing your pension can occur in various ways, such as:

taking a lump sum (known as an Uncrystallised Funds Pension Lump Sum or UFPLS),
taking income from flexi-access drawdown (tax-free cash only does not count),
or taking income above the cap from a capped drawdown fund.
use some or all of your pension benefits to purchase a short-term annuity.
taking income from a pre-2015 capped drawdown pension and the payments are more than the capped limit.

The MPAA will not affect you if you only have final salary or career average benefits, nor will it apply if you have a non-flexible annuity. Additionally, the MPAA will not apply to any future final salary or career average benefits that you may build up.

What happens if I exceed the MPAA?

If you exceed the MPAA, you may be subject to additional tax charges. The excess amount will be treated as income and taxed at your marginal rate.

Once you have flexibly accessed any pension, thereby triggering the MPAA, your pension scheme or provider will notify you. Following this, you must inform any other money purchase pension scheme which you, your employer, or a third party is contributing to on your behalf within 91 days. Failure to comply with this rule may lead to fines by HMRC. However, if you are only contributing to a defined benefit scheme, you are exempt from this requirement.

How much will I need to pay if I exceed the MPAA?

If the MPAA applies to you, any pension contributions made to money purchase pensions exceeding the MPAA during a tax year will result in a tax charge. This tax charge will be based on contributions made by you as well as on your behalf, such as an employer. Unlike the standard pension annual allowance, there is no option to carry forward any unused MPAA.

Here’s a bar chart illustrating the amount of tax a higher rate taxpayer may incur by contributing £20,000 into a money purchase pension while subject to the MPAA:

Please note, the above chart assumes the MPAA was triggered in a previous tax year and therefore money purchase contributions are limited to £10,000 overall.

The MPAA comes into effect from the date on which it is triggered and continues thereafter. For example, in the tax year in which the MPAA is triggered there are two annual allowance tests to consider. They are:

Has more than the standard annual allowance, which is currently £60,000 (or the tapered allowance for high earners), been paid into pensions over the entire tax year?

Did the contributions made from the date the MPAA was triggered until the end of the tax year exceed the MPAA limit, which is currently £10,000?

Why is the MPAA important for your retirement planning?

Many people rely on their pension to provide for their retirement, which is why it’s essential to think carefully before taking benefits from your pension and triggering the MPAA.

While taking benefits from your pension may seem like a good idea, especially if you need access to the money, maybe to fund a one-off cost like a child’s wedding or annual holiday, it’s important to understand the long-term impact it could have on your retirement planning.

By triggering the MPAA, you’re effectively limiting your ability to save further funds in your pension. This results in investing less wealth in a tax-efficient environment.

For example, let’s say that you’ve accessed your pension pot flexibly and triggered the MPAA. You’re now only able to contribute up to £10,000 per year to your pension. This can be detrimental to your retirement savings, especially if you have a high income and are still in the accumulation phase of your pension.

Conclusion

In conclusion, you should not take the decision to take benefits from your pension and trigger the MPAA lightly. It’s important to carefully consider the long-term impact it could have on your retirement planning and to explore all your options before making any decisions. If you’re unsure about what to do, it’s always a good idea to seek professional financial advice to ensure that you make the best decision for your individual circumstances.

If you have any questions about the MPAA or retirement planning in general, feel free to book an introductory call:

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Please take note of the following:

A pension is a long-term investment, and the value is not guaranteed. Any advice or considerations are personal to each individual’s circumstances.
A pension is a long-term investment, the value of your investment and the income from it may go down as well as up. Your eventual income may depend upon the size of the fund at retirement, future interest rates and tax legislation.
Levels and bases of, and reliefs from taxation are subject to change and their value depends on the individual circumstances of the investor.
Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation which are subject to change in the future.
This guide is for information purposes and does not constitute financial advice, which should be based on your individual circumstances.
The value of investments may go down as well as up and you may get back less than you invest.
This guide is for information purposes and does not constitute financial advice, which should be based on your individual circumstances
A pension is a long-term investment and the value is not guaranteed. Any advice or considerations are personal to each individual’s circumstances.
The value of investments may go down as well as up and you may get back less than you invest.
The Financial Conduct Authority does not regulate Cashflow Planning.