Help! I took a £20k pension and accidentally triggered the MPAA

I had a small personal pension valued at £20,000. I withdrew it in total earlier in the year as I needed it to pay bills during Covid-19. 

I paid 20 per cent tax on £15,000 and £5,000 was tax free.

I now realise I have triggered the money purchase annual allowance, giving me only a £4,000 tax free pension allowance a year going forward.

I have now got a government job with a defined benefit pension scheme where contributions will be more than £4,000.

Does the MPAA still apply as this new pension is a defined benefit pension and not a defined contribution one? Where do I stand?

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Steve Webb replies: Your question provides a timely reminder to anyone considering using their pension to tide them over in these difficult times that they need to think carefully about the implications of any decision they make now to access a pension pot.

For most people, the standard annual limit on pension contributions which can benefit from tax relief (known as the annual allowance) is £40,000.

Steve Webb: Find out how to ask the former Pensions Minister a question about your retirement savings in the box below

For those with the highest earnings this limit is reduced on a sliding scale. You can read more about the ‘tapered annual allowance’ here.

Your issue is slightly different.

When the Government introduced ‘pension freedoms’ in 2015 it made it much easier to get your money out of your pension.

Once you were 55 or over you could access your entire pension if you wished, taking a quarter tax free and paying tax on the rest.

One problem which the government foresaw was that people might try to abuse this new freedom.

There was a risk that people could empty out their pension pot, benefit from tax free cash and then put the whole lot back in again, topped up by tax relief.

This could then be accessed for a second time, with another 25 per cent being tax free and so on.

To try to prevent this from happening, the Government created a new limit on annual contributions which can benefit from tax relief.

This is called the money purchase annual allowance (MPAA).

If you access a chunk of cash from a defined contribution or ‘pot of money’ type pension, and if you take out more than the 25 per cent tax free lump sum, you are then subject to a much lower annual allowance.

The MPAA is currently just £4,000 per year. Note that the MPAA is not normally triggered when you cash in a small pension pot worth less than £10,000 – but you should check beforehand if you plan to do this – nor if you use everything except the tax-free lump sum to buy an annuity.

You have asked whether this is going to be a problem in your new job which has an old-style ‘defined benefit’ or salary-related pension and where the annual contributions are going to be more than £4,000 per year.

The good news is that this £4,000 limit only applies to future contributions into ‘pot of money’ type pensions and not final salary pensions.

This is explained in more detail on the website of the Money Advice Service here.

Although the MPAA is not going to be a problem for you personally, most people who start saving again into a pension will not be joining a final salary pension.

The majority of workers in the private sector can only save into a ‘pot of money’ type pension and in this case the MPAA of £4,000 would apply.

The moral of this story for anyone thinking of accessing their pension is to be aware of the risk that they may be severely restricting their ability to build up further pension savings in the future.

If they can find other ways to tide them over (for example, perhaps accessing money saved in an Isa) this might be a better option.