Unexpected consequences of pension allowance cut

Unexpected consequences of pension allowance cut

Changes in behaviour caused by cutting the money purchase annual allowance could significantly reduce the savings the government predicts this move will result in or end up costing it money, according to AJ Bell.

The government is hoping to save around £70m a year by reducing the money purchase annual allowance (MPAA) from £10,000 to £4,000.

But Sipp provider AJ Bell has calculated the proposed change could result in more pension tax relief being paid in a number of ways.

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For example, AJ Bell has predicted a ‘buy now whilst stocks last’ rush to use the £10,000 MPAA before April by people who weren’t previously considering contributions at that level but are able to make them.

Meanwhile the increased publicity and direct customer communication around the reduction could have the effect of encouraging more people to use the £4,000 MPAA from April.

Gareth James, head of technical resources at AJ Bell, said: “The proposed reduction in the MPAA becomes less and less compelling as a tax raising measure the more you think through how people might react to the reduction and what impact that would have.

“These behaviours could significantly reduce the amount the government saves if they result in more pension tax relief on additional contributions or reduced income tax from pension payments. 

“Certainly the £70m per annum the government has indicated it will raise looks overly optimistic.

“We could end up with a change targeted at a tiny proportion of people and unlikely to raise a huge amount for the government, actually changing the behaviour of a wider group of people and, if this turns out to be significant, potentially costing the government money in the short term.”

The government’s analysis shows only 3 per cent of over-55s pay in more than £4,000 to a pension, so the number of people who have accessed the pension freedoms and currently pay in more than £4,000 is going to be very small.

But Mr James also said the change could encourage a greater proportion of savers to only take the pension commencement lump sum so they retain the full annual allowance.  

There is an upper limit on the amount of pension commencement lump sum (or tax free cash as it is more commonly known) that is available to a member.

Tax free cash is limited, in broad terms, to 25 per cent of the value of the available standard lifetime allowance.

An increase in the number taking tax-free cash would allow those people to contribute more to pensions because rather than the MPAA being cut to £4,000 with no carry forward, it will remain at £40,000 with full carry forward.

It could also reduce the government’s tax take from the pension freedoms because people who would have been taking taxable income will choose not to take it.

Colin Thompson, a financial adviser with Hertfordshire-based Provisio Chartered Financial Planners, said: "It seems a bit of an odd decision. An annual allowance of £4,000 hardly seems worth having.