I took a £20k pension and accidentally triggered a tax limit on future savings – will this stop me putting money in my new job’s scheme? Steve Webb replies
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.
Retirement finances: I took a £20k pension and accidentally triggered a tax limit on future savings – will this stop me putting money in my new job’s scheme?
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.
What are defined contribution and defined benefit pensions?
Defined contribution pensions take contributions from both employer and employee and invest them to provide a pot of money at retirement.
Unless you work in the public sector, they have now mostly replaced more generous gold-plated defined benefit – or final salary – pensions, which provide a guaranteed income after retirement until you die.
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.
Ask Steve Webb a pension question
Former Pensions Minister Steve Webb is This Is Money’s Agony Uncle.
He is ready to answer your questions, whether you are still saving, in the process of stopping work, or juggling your finances in retirement.
Steve left the Department of Work and Pensions after the May 2015 election. He is now a partner at actuary and consulting firm Lane Clark & Peacock.
If you would like to ask Steve a question about pensions, please email him at email@example.com.
Steve will do his best to reply to your message in a forthcoming column, but he won’t be able to answer everyone or correspond privately with readers. Nothing in his replies constitutes regulated financial advice. Published questions are sometimes edited for brevity or other reasons.
Please include a daytime contact number with your message – this will be kept confidential and not used for marketing purposes.
If Steve is unable to answer your question, you can also contact The Pensions Advisory Service, a Government-backed organisation which gives free help to the public. TPAS can be found here and its number is 0800 011 3797.
Steve receives many questions about state pension forecasts and COPE – the Contracted Out Pension Equivalent. If you are writing to Steve on this topic, he responds to a typical reader question here. It includes links to Steve’s several earlier columns about state pension forecasts and contracting out, which might be helpful.
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