According to pension provider Aegon, more than half of those aged 50 or above have turned their back on a traditional retirement.

Nearly three-quarters (70%) of those surveyed said they wanted to reduce the number of days they worked and “ease” themselves into retirement, instead of finishing work for good.

Long gone are the days of the “golden handshake” on the day you reach State Pension Age, with a gold watch for the many years of loyal service, before embarking on a life of leisure. While there have always been some who mix part-time work with semi-retirement, it has now become a much more popular way of retiring.

More flexible rules around pensions allow you to draw an income in a way that suits you and your aims, allowing you to get used to retirement before jumping in feet first. But there may be a catch, and it’s one that has stung 1.6 million people in the last five years, landing them with a tax liability and – potentially – lower rates of growth of their pension pot.

It’s called the “Money Purchase Annual Allowance” (MPAA), and it snared 260,000 pensioners – or 1,000 pensioners every working day – in 2020 alone, research by the retirement specialists Just Group reveals.

Read on to discover more about the MPAA, and what it may mean for you.

Beware of the Money Purchase Annual Allowance, as you could be liable to its rules

Under Pension Freedoms, more people are choosing to subsidise their living through work and pension income. However, if you are doing this and, at the same time, contributing to another pension scheme, you need to be aware of the Money Purchase Annual Allowance (MPAA).

As the name suggests, the MPAA impacts you if you have a “money purchase” pension, also known as a “defined contribution” (DC) pension. As many workplace pensions are also money purchase schemes, these also fall under the MPAA rules, so speak with a professional financial planner to confirm whether this impacts you or not.

The rules mean that if you are taking an income from a money purchase pension your Annual Allowance – the amount you can contribute into a pension scheme and receive tax relief on – may be reduced from 100% of your income (up to £40,000) to just £4,000.

In other words, HMRC will not give you any tax relief once you have contributed £4,000 or more into a money purchase pension if you are taking an income from another, similar, pension.

The MPAA could impact on the future growth of your pensions

This means two things:

• You pay Income Tax on pension contributions above £4,000 under the MPAA rules when under normal Annual Allowance rules, you wouldn’t.
• Growth in your pension is potentially reduced.

To demonstrate the latter point, imagine the following: you work part time and earn £25,000 a year, and top this up with a small income of £5,000 a year from your private pension.

You decide you want to contribute £9,000 a year to another money purchase pension scheme to build it up for your full retirement.

Typically, this will be liable to the MPAA, meaning you receive tax relief on £4,000 worth of contributions, but not the remaining £5,000. If you pay Basic Income Tax of 20%, you will pay £1,000 on the £5,000 instead of the taxman adding this £1,000 to your pension.

As your pension does not receive the £1,000, the size of your pension pot is reduced and, therefore, the potential for growth is too.

You could take your tax-free lump sum and avoid the rules

One alternative could be to take the tax-free lump sum from your pension and not turn on any income.

As the MPAA is only triggered when you take an income, you could live off your tax-free lump sum alone and not fall under MPAA rules. But the rules can be complex, so always confirm your situation with a professional financial planner.

If you are in a workplace pension, you must take care

Typically, the MPAA is not typically triggered by a defined benefit (DB) pension – otherwise known as a “final salary scheme”.

But as explained above, if your workplace pension is a money purchase scheme, discuss your situation with a professional to confirm your situation, and what your options may be. If you do fall under the MPAA regulations, speak with your employer to ensure you do not breach the £4,000 allowance.

Get in touch

When you consider 1.6 million pensioners have been caught by the rules in the last five years, it’s clear the issue is widespread, and speaking with a professional financial planner will help you plan appropriately.

It is likely many of those caught by the MPAA would have had other options but didn’t know about them as they didn’t speak with a professional.

If you have any questions or concerns about the MPAA and how it might impact you, please contact us on 0800 434 6337.

Please note:

A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation which are subject to change in the future.

This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation which is subject to change.