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Tax Doctor: Avoid setting off the MPAA trap when dipping into pensions

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Tax Doctor: Avoid setting off the MPAA trap when dipping into pensions

Stewart wants to access his pension to tide him over after being fired, and by paying into small pots or as a lump sum, he will be able to do this free of the MPAA.

THE CASE

Stewart, who will be 58 next month, was recently fired from a consultancy firm where he had worked for 20 years.

He had expected to find new work swiftly so used his redundancy payment of £50,000 to pay the rest of his mortgage.

He has found a new 18-month consultancy job, but it will not start for a few weeks. He needs some income for daily needs and is considering withdrawing from his pension.

However, once he starts working again he’ll be paying back into his pension. He is worried he will trigger the money purchase annual allowance (MPAA), the limit on the amount he can pay into all his money purchase plans in any tax year, once he has flexibly accessed one of his pensions. The MPAA is currently £4,000.

THE PRESCRIPTION

To avoid over-paying tax because of the MPAA, Stewart can consider a few different alternatives. The solution will depend on what kind of pension arrangement Stewart has. If he has a modern pension arrangement, then there may be some flexibility in that account that could help Stewart avoid triggering the MPAA.

Past the tripwire

Stewart could look at paying benefits that are ‘small pots’. This option allows him to withdraw up to £10,000 on three occasions without activating the MPAA. Some schemes will allow existing pots to be split in order to allow withdrawals to be made under triviality without touching the remaining assets.

The payment of a pension commencement lump sum (PCLS) would also not trigger the MPAA, if the rest is put into a flexi-access drawdown scheme with no income withdrawn. So Stewart could withdraw up to 25% tax-free cash, which would not affect the MPAA. He could access the PCLS in one go or as a series of withdrawals. If taken as a series of withdrawals, he could do this until his PCLS entitlement is exhausted.

Stewart should also ensure he is accessing all of his other financial assets first. It is useful to think of pensions as ‘first in, last out’. So if Stewart or his wife have other assets, such as ISAs, they should access those first. He should also make use of his annual capital gains tax allowance, which currently stands at £11,100, before touching his pension.

Joining forces

He can also consider how his assets and his wife’s are split. Together they should discuss whether it would be appropriate for his wife’s pension to be topped up and if her ISAs should be accessed. By topping up her pension they will have the flexibility to either:

  • Access both pensions without triggering the MPAA, or
  • Access one pension that does trigger the MPAA for one of them, while maintaining the full annual allowance for the other.

The main problem with the MPAA is the lack of room to plan once it has been triggered, so forward thinking is key. Advice should also take into account other restrictions that could apply, such as the tapered annual allowance (the reduced annual allowance for high earners) and the alternative annual allowance (the annual allowance for defined benefit pension schemes when the MPAA is triggered).

Ian Browne is a pensions expert at Old Mutual Wealth

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