People aged 55 and over who have enjoyed the flexibility offered by pension freedom could soon see their choices restricted under proposals put forward by the Chancellor.

In his Autumn Statement on 23 November, Philip Hammond said the current Money Purchase Annual Allowance (MPAA) – the amount people can invest back into their pensions after withdrawing money – will be cut from £10,000 to £4,000 from April 2017, subject to consultation.

What is the MPAA?

The MPAA is the maximum amount of money you can pay back into your pension each year once you’ve taken income.

It isn’t triggered when you take your 25% tax-free cash lump sum, but comes into effect if you withdraw income thereafter. Any money you pay back into your pension over the allowance won’t benefit from pension tax relief.

Unlike the standard annual allowance – the amount people can pay into pensions before they start taking income – you can’t carry forward any unused MPAA from previous tax years.

Who would this affect?

The scenario of drawing an income and then paying money back into a pension sounds strange, but there are several situations when you might want to do this.

The first practice is the one the Government wants to stamp out – when people withdraw money and pay it back into their pension in order to benefit from double tax relief.

This is the reason the MPAA was first introduced when pension freedom was launched in April 2015; the proposed reduction suggests the £10,000 limit was an insufficient disincentive.

Another group who will be hit are those who want to cash in a small pension pot. Cashing in a pension pot of £10,000 or under won’t trigger the MPAA, but it will be triggered if the pot is larger than £10,000 and is being accessed via the Uncrystallised Fund Pension Lump Sum (UFPLS). The UFPLS allows you to access funds as a lump sum; 25% will be tax-free and the rest is taxed as income.

New restrictions

Patrick Connolly, head of communications at financial advice firm Chase de Vere, says it is common for individuals to use the UFPLS to pay off their mortgage or treat themselves to a holiday. These people will now be restricted to paying £4,000 a year into their pension.

Following the MPAA reduction, a better way of paying off your mortgage might be to take a 25% tax-free lump sum from a larger pension pot so the allowance is not triggered.

For example, you could take £25,000 tax-free from a £100,000 pension pot without triggering the allowance, whereas cashing in a smaller £25,000 pension pot would trigger the allowance and only £5,000 would be tax-free.

Thinking about a staged retirement?

The rule change could also affect people who choose to take a staged retirement. A recent YouGov poll for Old Mutual Wealth found 30% of 50 to 75 year-olds expect a job to help fund their future retirement income needs.

Karena Woodall, consultant at Mattioli Woods, says many people who have reduced their working hours would have done so in the belief they could use their pension to supplement their income and still contribute up to £10,000 a year. Their ability to contribute to the future via a pension plan is effectively being restricted by 60%.

‘What happens if the reduction to £4,000 results in them being subject to annual allowance charges? Mandatory scheme provisions require a tax charge of at least £2,000, based on the normal annual allowance of £40,000,’ Woodall says.

Made redundant then found a new job?

People who have been made redundant at age 55 or older may also have started drawing an income, thus triggering the MPAA. If they get a new job, their combined individual and company contributions could easily breach the new £4,000 annual limit.

‘The reduction is significant for those who may find their circumstances change and they return to work or even take up a consultancy role,’ says Claire Trott, head of pensions strategy at Technical Connection.

‘They are earning income and may cease accessing their funds but there is no going back to the higher amount. It is unfair to penalise people who have been actively encouraged to flexibly access their benefits from age 55.

‘Those that actually recycle any income into pensions is few and far between but these changes could adversely impact those that had no choice through redundancy or other reasons.’

Pension planning

Connolly says the MPAA reduction makes it even more important for people to think long and hard before taking pension benefits and understand the full implications of doing so.

If you have previously triggered the allowance, you’ll need to review how much you’re investing into pensions in order to ensure your contributions are fully tax-efficient.

Is an ISA the solution?

If you have more than £4,000 to invest you could consider putting money into an ISA instead.

From April 2017, you’ll be able to pay £20,000 into ISAs each year. This won’t help you get around the issue of employer pension contributions, although Retirement Advantage’s Andrew Tully says you could try asking for a higher salary instead of a pension contribution if you’ve triggered the MPAA.

Another alternative is to put the money into a venture capital trust (VCT) or Enterprise Investment Scheme (EIS), both of which offer up to 30% income tax relief, subject to various conditions such as holding the investments for many years.

Connolly says these are higher-risk investments and are only suitable for people who have a large portfolio, who have used up their pension and ISA allowances, and who are happy to take on more risk.

To avoid triggering the MPAA in the first place, Jon Greer, pensions expert at Old Mutual Wealth, suggests combining the use of pension tax-free cash with ISA withdrawals, tax-free bond withdrawals and capital gains (within the annual capital gains tax allowance). This will effectively extend the period over which higher future annual pension savings can be made.

‘The best course of action is to take advice to consider how any pension withdrawals will impact your long-term ability to save into pensions,’ Greer adds.

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