Tax  

How to overcome pension tax allowance cut

How to overcome pension tax allowance cut

Savers can maintain existing levels of savings by redirecting pension contributions into a spouse’s or child’s pension after the cut in the money purchase annual allowance (MPAA), according to Prudential.

The reduction in the MPAA to £4,000 - down from the current £10,000 - will be reintroduced in tomorrow’s (6 September) Finance Bill.

It was previously dropped in March, alongside a number of changes to tax legislation, due to the general election in May.

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The money purchase annual allowance is the amount a person who has already begun drawing on their pension can pay in one year back into their retirement savings without a tax charge applying.

Experts have warned that the cut in the MPAA is set to further complicate pensions and sends the wrong message about savings.

Les Cameron, retirement expert at Prudential, said that “the government’s rationale is to stop people taking money out of their pensions and recycling this to benefit from tax relief twice”.

However, he said there is a solution to increase the savers “family’s overall wealth without falling foul of the rules.”

In Prudential’s case study, a basic rate taxpayer takes £10,000 out of their pension. If this is taxed at 20 per cent, they would be left with £8,000.

If they reinvest this amount in a partner’s pension, it will attract tax relief increasing the contribution to £10,000.

After tax-free cash and basic rate tax, the partner’s pension delivers £8,500.

Which is an increase of £500 when compared to a situation without the tax-free cash.

Benefits for basic rate taxpayers

Pension
withdrawal

Amount after 20%
tax deducted

Amount reinvested
in spouse’s pension

Gross contribution (after
basic rate tax relief added)

25% tax-free
cash removed

Balance of fund
less 20% tax

£10,000

£8,000

£8,000

£10,000

£2,500

£7,500 - £1,500

= £6,000

According to Billy Burrows, director of Retirement IQ, “the idea of diverting contributions to a partner’s pension make sense."

However, he added, “with most things to do with pensions, the devil is in the detail so it is important to get advice."

Mr Cameron agrees.

He said: “Tax can be complicated and taking professional advice will help savers avoid pitfalls.”

maria.espadinha@ft.com