As workplace flexibility increases and people earn a salary even after they start to draw their pension(s), changes to contribution allowances, tax legislation and the advent of auto-enrolment need to be understood to avoid an unwelcome tax bill.
The majority of people who have accessed their pension while continuing to work are likely to have no concept of the Money Purchase Annual Allowance (MPAA), let alone any changes to it.
The MPAA was introduced in April 2015 at the same time as pension freedoms, imposing a £10,000 annual pension contribution limit on individuals who are drawing down their taxable pension.
The new flexibility means many may access their pension before retiring and HMRC wanted to prevent them from:
- diverting a significant proportion of their salary into their pension then immediately withdrawing large sums (up to 25% of their pension pot)
- recycling tax-free cash lump sums.
The £10,000 threshold was unlikely to catch many unawares. However, we expect that the MPAA will reduce to £4,000 this year*, now the general election has been held and a Conservative government, albeit a minority one, has been returned. This limit is more likely to affect those drawing pension benefits and contributing simultaneously.
MPAA and auto-enrolment increases
One area often overlooked is the interaction of this limit with the increase in automatic enrolment contributions that will be phased in April 2018 and April 2019.
Here, employees of a qualifying workplace scheme will automatically have their contributions increased according to a mandated scale.
Assuming the £4,000 contribution limit is introduced and an employee contributes the minimum to a workplace pension, it would be breached by an £80,000 earner in 2018 and £50,000 earner from 2019 under the relevant minimum contributions rates .
If a pension scheme member exceeds the £4,000 threshold, there is no automatic mechanism to alert the member to the danger of a tax charge - if the member independently withdraws some of their pension pot (many now have more than one) while the employer and the member contribute to the current scheme.
The increase in flexible working potentially compounds this issue, as more Britons continue to work over the age of 55 and may supplement salaries through ad hoc withdrawals assuming they can rebuild their capital penalty- and tax- free. However, they will be subject to the MPAA and their membership of the employer’s pension scheme may result in contributions that result in a tax charge.
Employers who take an active role the financial education of their workforce may want to be proactive and make their staff aware of this issue, its implementation date, and of ways staff can monitor their contributions and withdrawals.
* At the time of writing it was not clear whether this clause will have retrospective powers back to 6 April 2017 or if it will take effect from 6 April 2018.
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.
This article was previously published on Smith & Williamson prior to the launch of Evelyn Partners.