Every year you’re able to pay a certain amount of money into your pension. But if you’ve taken money out of your pension, you may be able to pay in much less. In that case, you’ll be limited by the money purchase annual allowance. How does the money purchase annual allowance work?
The money purchase annual allowance explained
The money purchase annual allowance or MPAA is the amount of money you can pay into a pension every year and get tax relief if you’ve already cashed in some or all of a pension pot type of pension.
SAVVY TIP: By pension pot I mean a pension that’s not linked to your salary in the same way that a final salary pension is. A pension pot type of pension could be a defined contribution (otherwise called ‘money purchase’) pension from your workplace, or a personal pension.
The money purchase annual allowance is £4,000 a year in the tax year 2018 – 19. It was introduced in April 2015 and was originally set at £10,000. However, it was reduced from April 6th 2017. This compares to the ‘normal’ pension contribution limit, which lets you pay up to £40,000 a year or 100% of your income, into a pension and still get tax relief.
SAVVY TIP: The money purchase annual allowance includes any money that you and your employer (if you have one) pay into your pension.
Who is affected by the money purchase annual allowance?
If you take your 25% tax-free cash lump sum out of your pension pot and use the rest to buy a fixed lifetime income with an annuity, that doesn’t trigger the money purchase annual allowance. The money purchase annual allowance also isn’t triggered if you take out the 25% tax-free cash lump sum and put the rest of your pension into flexible (or flexi-access) income drawdown but don’t then take any more money out of it.
JARGON ALERT! Flexible or flexi-access drawdown is a form of income drawdown where you can take different amounts of income from your pension pot or take no income at all. It’s become much more popular since the pension freedoms were introduced in April 2015.
However, if you were to take out more money than the 25% tax-free cash lump sum, or if you took out cash lump sums from your pension, you would be likely to be affected by the money purchase annual allowance.
SAVVY TIP: It’s worth knowing that the money purchase annual allowance doesn’t apply if you’ve cashed in a pension or pensions worth less than £10,000 in total.
How taking money from your pension could trigger the money purchase annual allowance
What does that mean in practice? Well, if you take out tax-free cash from your pension and use the rest to buy a lifetime income with an annuity that’s not investment linked, you’re not affected by the money purchase annual allowance. Instead, you can continue paying up to 100% of your salary, or £40,000, whichever is lower, into your pension every year and still get tax relief.
SAVVY TIP: Tax relief means that some tax you’d normally pay to the government goes into your pension instead. You can read more about how tax relief works in my article.
However, if you’ve taken one or more lump sums direct from your pension or you’ve used something called ‘flexi-access drawdown’, you will be affected by the money purchase annual allowance. This means you’ll only be able to pay up to £4,000 a year into your pension.
When does the money purchase annual allowance take effect?
The MPAA takes effect immediately after you’ve taken your pension benefits flexibly. This means that you may be able to time things so you can pay extra money into your pension before you take cash out of it.
Use it or lose it!
With your normal pensions annual allowance, you can go back up to three years and fill in the gaps. This means that if you’ve not used up your annual allowance in the past, you may be able to pay in more than £40,000, or your salary level, in a single year.
However, with the money purchase annual allowance, you’re not able to go back and fill in the gaps. So if you don’t pay the maximum amount of £4,000 into your pension one year, you can’t go back later and use that allowance. Like the ISA allowance, if you don’t use it, you’ve lost it forever.
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