Limit will decrease from £10,000 to £4,000.
Once a person has accessed pension savings flexibly, any further contributions to a DC pension qualify for tax relief only if they are restricted to the money purchase annual allowance (MPAA).
Since 6 April 2015, on reaching the normal minimum pension age of 55, a person can access their pension flexibly, and continue to make additional contributions up to £10,000 and obtain tax relief on those new contributions.
The MPAA is to be reduced to £4,000 with effect from 6 April 2017 onwards.
What does accessing a pension flexibly mean?
Accessing a pension flexibly means taking benefits from a DC pension scheme by one or more of the following means:
- a flexi-access drawdown fund (whether or not having also taken a tax-free lump sum), which can be either
(a) income withdrawal, as and when required
(b) a short-term annuity
- a lifetime annuity that allows actual or possible decreases in the amount of annuity payable
- a one-off payment, known as an ‘uncrystallised funds pension lump sum’, is paid for the first time – one quarter of which is tax free
- a stand-alone lump-sum payment is made where the person has primary protection and a protected tax-free lump sum right that is greater than £375,000
- a pension scheme delivers the DC pension directly – a ‘scheme pension’ – and there are fewer than 12 individuals receiving a scheme pension
- payment of one of the types of benefits listed above is from an overseas pension scheme that has benefited from UK tax relief.
What does not constitute accessing a pension flexibly?
Other types of pension options do not constitute accessing benefits flexibly, for example:
- payment of funds from a money-purchase arrangement as a ‘small lump sum’ (A pension pot of up to £10,000 can be exchanged for a lump sum, 25% of which is tax-free.)
- payment of a trivial commutation lump sum
- where a member was drawing savings through a ‘capped drawdown’ arrangement before 6 April 2015 and has not taken an amount from that arrangement that exceeds their maximum capped drawdown amount.
- the tax-free lump sum withdrawals (up to 25% of the value of the DC pension scheme if withdrawals have not previously been made from that fund and subject to various restrictions) known as pension commencement lump sum
- payments from a dependants’ flexi-access drawdown fund.
What is the effect of the money purchase annual allowance?
A person’s ability to make tax-free contributions to a pension scheme is subject to an annual allowance (AA), which is normally £40,000. If a person exceeds the annual allowance in a tax year, the excess is subject to tax at the individual’s marginal rate. However, once a person has flexibly accessed their pension, they are subject to the MPAA, currently £10,000, for all subsequent contributions to a DC pension.
Normally, up to three years’ unused AA can be carried forward and set against contributions in a subsequent year. However, unused relief carried forward cannot be used to bolster the MPAA. Also, any unused MPAA cannot itself be carried forward.
When a person first accesses money purchase savings flexibly (a trigger event), the savings made in the tax year are apportioned into the amount that arose up to and including the date of the trigger event and the amount that arose after the trigger event. Only the latter are tested against the MPAA.
If a person is subject to the MPAA and they are also accruing defined benefit (DB) pension rights, the total AA for DB and DC remains at the standard £40,000. DC savings are subject to the MPAA and, if these exceed the MPAA, any excess is charged to tax. However, the AA available for DB is also reduced to £30,000 (plus any unused AA carried forward) and the DB savings are tested against this alternative annual allowance, so no savings are tested twice.
Karen has a money purchase arrangement with a fund value of £7,000 in a non-occupational pension scheme and wants to access all the funds in the arrangement as a lump sum.
As the fund value does not exceed £10,000, Karen can take the whole amount as a ‘small lump sum’ as she meets the necessary conditions for such a lump sum to be paid, provided that she has not previously received three such lump sums from non-occupational pension schemes. The lump sum is paid 25% tax free, with the remainder of £5,000 chargeable to income tax as pension income.
Payment of the ‘small lump sum’ is not a trigger event for the money purchase annual allowance.
If Karen has previously received three such ‘small lump sums’ from non-occupational pension schemes, she could not receive a further ‘small lump sum’. Karen can still take the £7,000 as a lump sum but as an uncrystallised funds pension lump sum, which will also be paid 25% tax free and 75% chargeable to income tax as pension income.
Payment of an uncrystallised funds pension lump sum is a trigger event for the money purchase annual allowance. However, a payment of pension commencement lump sum is not a trigger event.
Article from ACCA In Practice