How to avoid a 90% annual allowance cut if you need to access your pension

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Even before Covid-19 hit, the money purchase annual allowance (MPAA) felt like an unfair punishment for savers whose only crime was accessing taxable income from their pension pot.

During this crisis many more over 55s will be facing salary cuts or joblessness, while others will need to use their savings to help loved ones struggling to make ends meet. In such an environment, hitting people with a 90% annual allowance cut for taking even £1 of taxable income from their pension feels deeply unjust.

During the early stages of lockdown 1-in-10 over 55s said they had accelerated plans to access their retirement pot*, and many more are likely to consider doing this as the Government support for businesses is pulled back between now and October.

But with ministers refusing so far to take action on the MPAA, savers need to watch their step or face being hamstrung as they look to rebuild their retirement savings.

Three ways to take money out of your pension without triggering the MPAA:

1. Consider only taking your 25% tax-free cash

While taking taxable income from your pension risks triggering the MPAA, just taking your 25% tax-free cash won’t. In order to access your tax-free cash you’ll need to ‘crystallise’ some or all of your pension – this just means choosing a retirement income route such as drawdown or buying an annuity.

It is, however, possible to crystallise part of your pension in order to access just some of your tax-free cash, leaving the remaining fund – including any further tax-free cash element – untouched.

Take, for example, someone with a total pension pot worth £100,000. If they wanted to take out £5,000 to help a relative struggling during Covid-19, one option would be to crystallise £20,000 of their pension, with £15,000 going into drawdown and £5,000 available as tax-free cash.

2. Take advantage of little-known ‘small pots’ rules if you can

While flexibly accessing taxable income from your pension will see your annual allowance reduced by the MPAA, there are ‘small pots’ rules which allow you to make taxable withdrawals while retaining your full annual allowance.

A small pot in this case is defined as a pension arrangement worth £10,000 or less. In order to class as a small pots withdrawal (and thus avoid triggering the MPAA), you must extinguish the entire pension pot you are accessing.

You can make unlimited small pots withdrawals from any occupational defined contribution pension plans worth £10,000 or less. These are simply any pensions you may have which were set-up by an employer.

For non-occupational DC plans such as SIPPs, you can close up to three different pension pots by making a maximum of three small pots withdrawals.

3. If you’re in ‘capped’ drawdown, don’t exceed your maximum income

If you entered ‘capped drawdown’ before 6 April 2015 and stay within your income limits you will not trigger the MPAA.

Savers in capped drawdown have their fund invested and take withdrawals from their fund in the same way as regular drawdown. However, the key difference – as the name suggests – is withdrawals are capped at 150% of the equivalent Government Actuary’s Department (GAD) annuity rate.

Although this might sound complicated, it just means you can withdraw up to 150% of the income a healthy person at your age could receive from a lifetime annuity. If you take out more than this limit then you will have been deemed to have flexibly accessed your pension and so will trigger the MPAA.

You can also consider an annuity

If you’re looking to take out more than your tax free cash, but don’t want to trigger the MPAA by taking money out of the remaining drawdown fund, choosing an annuity might be an option.

Because most annuities offer you a steady income, you’re not treated as flexibly accessing your pension, so won’t trigger the MPAA.

Care is needed though. A few annuities offering flexibility to reduce income will trigger the MPAA. You need to remember that once you’ve chosen an annuity you can’t switch back to drawdown. And you should shop around to find the best annuity for you, including taking advantage of any income enhancements available for health reasons.

*Source: A survey of 2,002 UK adults conducted for AJ Bell by Opinium between 24 – 27 April 2020

Please also bear in mind that pension scams claiming to allow people early access to their pension have increased. Find out more about how to avoid becoming a victim of pension scams.

Important information: How you're taxed will depend on your circumstances, and tax rules can change. Pension rules apply. These articles are for information purposes only and are not a personal recommendation or advice.


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Written by:
Tom Selby

Tom Selby is a Senior Analyst at AJ Bell. He is a multi-award-winning former financial journalist specialising in pensions and retirement issues. Tom has over five years' experience working at Money Marketing magazine, where he became the Head of News in 2014. He has a degree in economics from Newcastle University.