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Massive tax bill created by pension allowance change

Massive tax bill created by pension allowance change

Alastair Black, head of financial planning propositions at Standard Life, has warned higher rate tax payers need to check the way they access their pension cash or face a massive tax bill.

In the Autumn Statement, chancellor Philip Hammond announced the money purchase annual allowance will be cut from £10,000 to £4,000 in April 2017.

Mr Black said higher rate tax payers who exceed the £4,000 limit from April onwards and access their cash through uncrystallised fund pension lump sum are unlikely to be aware this way of taking their pension pot will create a tax charge.

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He said: "If a scheme only facilitates this through uncrystallised fund pension lump sum (UFPLS), in which one quarter is tax free and three quarters is taxed, then a higher earner could take his lump sum unaware that he will get hit with a tax bill for exceeding the new £4,000 limit.

"If he is in a flexible product that already allows a 25 per cent tax-free lump sum to be taken without UFPLS, he won’t be adversely impacted."

Mr Black provided a case study in which an individual on a £40,000 salary with a generous matching defined contribution pension scheme, meaning the total of all contributions into the scheme - employer, employee and tax relief - make 20 per cent.

He said this means they have £8,000 paid into their scheme on their behalf.

The following table represents the impact of taking a lump sum to fund by both routes:

 Modern scheme with Flex DDPlan with limited UFPLS capability only

£10,000 lump sum taken to fund (whatever is appropriate)

By tax free cashBy UFPLS

Before change to MPAA - £8,000 contribution a year

MPAA doesn’t apply as tax free cashMPAA applies at £10,000 – no tax to pay
New MPAA £4,000MPAA doesn’t apply as tax free cashMPAA applies at £4,000 – tax to pay
Extra tax (unexpected?)£0£800 a year

Les Cameron, head of technical at Prudential, said: “The reduction in the money purchase annual allowance at face value seems as if it may not cause any problems as the £4,000 limit is substantially higher than the current minimum contributions for auto-enrollment.  

"However, many workplace pension schemes have contribution arrangements that are far more generous than this amount.

"For example, some employers often pay into a pension without the employee needing to make contributions and will then go on and match any contribution the employee is willing to make - a total contribution of 18 per cent will not be uncommon.

"This means that anyone earning the national average wage, currently around £27,000, who has flexibly accessed their benefits will suffer a tax charge.

“Many schemes introduced the new uncrystallised fund pensions lump sum as a way of giving members access to pension freedoms but did not allow flexi-access drawdown.  

"The issue is you trigger the money purchase annual allowance by taking an UFPLS however if you use flexi-access drawdown and just take your tax-free cash sum then you don’t trigger this reduction.  

"People will need to make sure they can access freedoms in a way that doesn’t trigger the money purchase annual allowance if this new limit is going to be an issue.”

Colin Rodger, director at Edinburgh and Glasgow-based Alexander Sloan Financial Planning said: "After some of the rumours, I suppose we should be grateful the Autumn Statement didn’t interfere more but I do wish Government would stop tinkering with pensions, this is yet another complication and potential tax trap for the unwary."