In April 2015, those who had reached age 55 could choose to take some of their entire money purchase pension as a lump sum. Were it not for the Money Purchase Annual Allowance (MPAA), this could have enabled pension members to sacrifice salary for employer pension contributions and to immediately withdraw, thereby saving tax and national insurance (NI).
The government solution was to introduce a £10,000 MPAA for those who flexibly accessed their pension on or after 6 April 2015.
Any money purchase pension contributions that are in excess of the MPAA are taxed as the highest slice of income; in most cases removing the tax benefit of the pension contribution, as Box 1 shows.
Flexibly accessing pensions
The most common ways of flexibly accessing pension rights are by taking income from flexible drawdown or by taking a horribly named Uncrystallised Funds Pension Lumps Sum (UFPLS). Taking the 25 per cent tax-free cash and moving into drawdown without taking an income does not trigger the MPAA, and neither does buying a standard annuity.
The MPAA only affects contributions that have been paid after it is triggered. It is not pro-rated if triggered part way through the tax year. This means it is possible to make a £20,000 pension contribution the day before triggering the MPAA, for example.
Avoid an HMRC penalty
The first time a client flexibly accesses a pension with a specific pension provider they will be issued with a flexible access statement. They have 91 days to pass on this statement or otherwise notify every pension scheme in which they are accruing benefits. Broadly, this includes any pension scheme that is receiving individual, employee or employer pension contributions. If they subsequently start contributions, the 91 days commences from the date of the first contribution.
Failure to notify could result in an initial £300 penalty from HM Revenue & Customs and then up to £60 for each subsequent day.
The tax charge
Any money purchase contribution in excess of the MPAA is added to the top slice of income and taxed according to the tax band in which it falls. This tax charge cannot reduce your personal allowance, even if the MPAA excess plus taxable income is more than £100,000 (see Box 2). A number of tax incentives can work by reducing the tax bill, rather than by reducing taxable income. These include incentives for investing in Venture Capital Trusts (VCT), Enterprise Investment Schemes (EIS) and the Seed Enterprise Investment Schemes (SEIS).
This tax reduction is only fully allowable if the individual is paying sufficient income tax. When calculating whether sufficient income tax has been paid, the annual allowance tax charge is not taken into account and therefore cannot be reduced by a tax-reducer.
Carry forward
Unused annual allowance can be carried forward for up to three tax years, potentially allowing for a pension contribution in excess of £40,000 without an annual allowance tax charge. It is not possible to carry forward unused annual allowance to increase your MPAA or to carry forward unused MPAA. Carry forward may still be useful if a client also has a defined benefit, for example a final salary pension scheme.
If scheme pays is not available
If they are subject to an annual allowance charge, a client can compel their pension scheme to pay this charge from their pension fund. This is known as scheme pays. To do so the tax charge must be at least £2,000 and they must have exceeded that year’s annual allowance (£40,000 in 2016/17) in that pension scheme. If the MPAA has been exceeded, but not the annual allowance, a pension scheme cannot be compelled to use scheme pays. Some pension providers may do so voluntarily.
Refund on MPAA limit
If you make a personal contribution in excess of your relevant UK earnings you can receive a refund of the net contribution with the excess tax relief being returned to HMRC. This is not possible with the MPAA. The only option is to pay the tax charge.
Final salary schemes
As the name suggests, the MPAA only applies to money purchase arrangements. It does not apply to defined benefit arrangements. For a complete understanding of how the legislation works it is necessary to understand:
• The money-purchase input sub-total.
• The defined-benefit input sub-total.
• The default chargeable amount.
• The alternative chargeable amount.
Fortunately, to understand the impact of this part of the legislation it is only necessary to know that there is a standard annual allowance, and within this there is the MPAA. If either the MPAA or standard annual allowance is breached there will be a tax charge, but it is not possible for the same contribution to be subject to both a MPAA and an annual allowance tax charge (see Box 3).
Impact on auto enrolment
By February 2018, all employers will be subject to AE. From April 2019, the minimum contribution based on pensionable salary will be 9 per cent; more generous employers will contribute more. Table 1 illustrates the minimum pensionable salary that can be paid before an annual allowance tax charge would be triggered, based on various percentages of pensionable salary and assuming a £4,000 MPAA.
It is possible that an employee who has triggered the MPAA and is only contributing on the standard basis used by their employer could be subject to an annual allowance tax charge. This briefly summarises some aspects of the MPAA. At the time of writing, the MPAA reduction to £4,000 is under consultation and may change. But the quirks should still remain.
Phil Warner is head of technical at Hargreaves Lansdown
