Millions fall foul of pensions contributions rule

Almost a million savers could face punitive tax charges on their pension contributions because they have unwittingly triggered a substantial reduction in their annual contributions allowance.

948_MW_P25_Pensions
Part-time work could boost your pension contributions tax bill

The money purchase annual allowance has had some unintended consequences

Almost a million savers could face punitive tax charges on their pension contributions because they have unwittingly triggered a substantial reduction in their annual contributions allowance. Between April 2015 and September 2018, 980,000 people made flexible withdrawals from their pension fund, according to pension provider Just Group.

They may now fall foul of the money purchase annual allowance (MPAA). This rule reduces the normal £40,000 annual allowance on pension contributions by a factor of ten. If you go over £4,000, you are taxed at your highest rate of income tax on the excess.

The MPAA was introduced alongside the pension freedom reforms of April 2015 to prevent people making withdrawals from their savings only to immediately reinvest this money to claim extra tax relief. However, it is now catching people out in ways policymakers didn't anticipate. Some people, for example, have taken advantage of the pension freedoms to move into part-time work, making withdrawals from their pension savings to maintain their income but continuing tocontribute.

People with irregular earnings, including the self-employed and directors, have also dipped into pension funds in order to smooth out their income, but have every intention of continuing to save. Even those taking an income but not expecting to make further contributions may change their mind if their circumstances change because they receive a pay rise, say.

When does it apply?

The MPAA will also apply if you move your savings into a "flexi-access drawdown scheme" and begin taking an income, or if you just cash in your entire pension as a lump sum, though there is an exception for those cashing in small funds worth less than £10,000. Savers buying investment-linked annuities offering variable levels of income are also caught but not those with conventional annuities with a guaranteed level of income for life.

Finally, note that savers affected by the MPAA don't even have the option of using the carry-forward rules, which allow most people to mitigate their exposure to tax by bringing forward unused pension contribution allowances from the previous three years.

Recommended

What are the best ways of raising more money in tax?
Economy

What are the best ways of raising more money in tax?

Given that whoever wins next week's election will be going on a massive spending spree, we're going to need to raise at least some of that money throu…
5 Dec 2019
What are the biggest mistakes investors make when it comes to tax?
Investment strategy

What are the biggest mistakes investors make when it comes to tax?

The tax implications of an investment are something we rarely consider until after the event. That could prove to be an expensive mistake, says Domini…
27 Nov 2019
Great frauds in history: the Independent West Middlesex Fire and Life Assurance Company's early Ponzi scheme
Investment strategy

Great frauds in history: the Independent West Middlesex Fire and Life Assurance Company's early Ponzi scheme

The Independent West Middlesex Fire and Life Assurance Company (IWM) offered annuities and life insurance policies at rates that proved too good to be…
21 Oct 2020
Mukesh Ambani: the Indian billionaire eyeing global expansion
People

Mukesh Ambani: the Indian billionaire eyeing global expansion

Mukesh Ambani is already the richest man in India by a large margin, but his ambitions do not end there. He wants India to be at the front of the worl…
19 Oct 2020

Most Popular

How will we repay our vast debt pile? Do we even need to?
Sponsored

How will we repay our vast debt pile? Do we even need to?

In his recent articles looking at different aspects of the fixed-income investing world, David Stevenson looked at inflation. Today he looks at a clos…
19 Oct 2020
Negative interest rates and the end of free bank accounts
Bank accounts

Negative interest rates and the end of free bank accounts

Negative interest rates are likely to mean the introduction of fees for current accounts and other banking products. But that might make the UK bankin…
19 Oct 2020
The Bank of England should create a "Bitpound" digital currency and take the world by storm
Bitcoin

The Bank of England should create a "Bitpound" digital currency and take the world by storm

The Bank of England could win the race to create a respectable digital currency if it moves quickly, says Matthew Lynn.
18 Oct 2020