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Pension rules in the UK are notoriously complex. Not only are there multiple types of pensions to deal with, but drawing from them needs to be planned carefully. For instance, did you know that the State Pension is accessible from your State Pension age – 66 in 2021 – but you can only access your defined contribution pension(s) from age 55 (under the 2015 Pension Freedoms)? This latter rule can be exciting for many people, since it could allow them to “semi-retire” early from your mid-50s; i.e. continue to work in some capacity, whilst drawing from a pension. Yet doing so can trigger a little-known rule which can have significant consequences for your overall retirement plan – the Money Purchase Annual Allowance (MPAA).
What is the MPAA?
The UK Government wants people to plan ahead for their retirement, and so offers savers a nice set of tax benefits in a pension. Yet they also want to prevent exploitation of these benefits. Take the Annual Allowance as a case in point. In 2021-22, you (and your employers) can save up to £40,000 in a pension in the tax year, receiving tax relief on your personal contributions, capped at the equivalent of your salary. So, for someone on the basic rate, it costs 80p to personally put £1 into his/her pension. For the higher rate, it is 60p.
This system allows people to boost the growth of their pension pot with time and good planning. However, once you trigger the MPAA rules, your annual allowance is reduced by up to 90% – i.e. from up to £40,000 per tax year, down to £4,000. Any pension contributions made over this will, therefore, be subject to a charge. One of the “triggers” includes drawing an income from a Flexi-Access Drawdown pension. As such, for those looking to continue working whilst taking money from their pension, there is a risk of inadvertently pulling the trigger.
How to navigate the MPAA
Once you trigger the MPAA rules, there is no going back. Given the restrictions this places onto your retirement saving ability, it is crucial to not do this until you are absolutely ready. The good news is that it is possible to carefully navigate your way around the MPAA rules with the help of an experienced financial planner.
For instance, if you want to take some money from your pension whilst continuing to work (and also not trigger the MPAA rules), then you can usually withdraw up to 25% from your pension pot(s) safely – although you should seek advice first. This money could then be put into income-producing investments if you wanted to supplement your salary (e.g. dividend investments in an ISA structure). Another option might be to downsize into a home which you can pay off in full. This could remove the monthly commitment to repay a mortgage – thus potentially allowing you to scale back on hours, without needing to draw from a pension.
Another idea may be to look at your other, non-pension assets and investments to boost your income leading up to retirement. This could include income from property investments (e.g. a Buy-to-Let where the mortgage has almost been repaid), providing regular rental income from tenants. Another source could be income produced from an investment portfolio which doesn’t sit within a pension structure – e.g. a general investment account. There is also a caveat to the MPAA rules which you may wish to consider. Small pension pots under £10,000 can be cashed in, typically, without triggering the rules. You could explore this with your adviser, for instance, prior to consolidation.
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