Rule is intended to put people off recycling their pension withdrawals back into pots, in a bid to benefit from double tax relief
The Government is being urged to relax a tax rule aimed at deterring ‘pension recycling’ because it hinders savers who start dipping into pots from replenishing them again.
The rule stops anyone who has made a withdrawal over and above their 25 per cent tax free lump sum, from benefiting from valuable tax relief on contributions worth more than £4,000 a year from then onward.
It is intended to put people off recycling their pension withdrawals back into their pots, in a bid to benefit from the same tax relief twice.
But it is also a barrier to retirement saving for people who want to return to work and build up a further pot, according to a letter to the Treasury from 17 financial firms and industry groups.
They want the annual savings limit of £4,000 hiked back up to £10,000, where it was set when new freedoms to access pensions were first introduced in 2015.
If you only qualify for the new lower limit – known in industry jargon as the ‘money purchase annual allowance’ or MPAA – you risk a shock tax bill if you unwittingly pay in too much.
The industry letter, signed by firms including Hargreaves Lansdown, AJ Bell, Fidelity and Aegon, received a mixed reaction from others in the industry and an unpromising response from the Treasury.
A pension specialist at financial consultant Barnett Waddingham called for the MPAA to be scrapped altogether in the Budget on 15 March.
Navigating the system is a minefield for those who have dipped into their pension but are now returning to work, says James Jones-Tinsley, who added: ‘Abolishing the MPAA would be an excellent choice for the Chancellor’s “rabbit out of the hat” on Budget Day.’
But Henry Tapper, the influential founder of the Pension Playpen professional network, says recycling pension contributions to get double tax relief is ‘not victimless’ because it comes at the expense of the Treasury and is ultimately paid for by people not gaming the system.
What limits are placed on receiving pension tax relief?
Pension tax relief allows everyone to save for retirement out of untaxed income.
You receive rebates, effectively free cash from the Government paid into your pension, based on your income tax rate of 20 per cent, 40 per cent or 45 per cent.
The standard amount you can put in your pension every year and qualify for tax relief – including your own and your employer’s contributions, and the tax relief itself – is £40,000.
The rules are more complicated for higher earners, whose annual allowance is ‘tapered’ down to either £10,000 or £4,000.
When you start tapping a defined contribution pension pot for any amount over and above your 25 per cent tax free lump sum, you are only able to put away £4,000 a year (the MPAA) and still automatically qualify for valuable tax relief from then onward.
Meanwhile, there is a lifetime allowance which is currently £1,073,100, and if it is breached you face tax charges on the income or lump sums.
> How to defend your pension from the taxman: Read our guide here.
‘The MPAA – a tax on privilege – is an incentive for the well-off to pay attention to the tax rules rather than be a pension Muppet,’ he says. Read Tapper’s full take below.
A Treasury spokesperson says: ‘We are committed to supporting the nation’s savers and have a range of incentives in place to encourage people to invest for their retirement.
‘The MPAA affects around 25 per cent of occupational defined contribution savers aged 55 and over.
‘The cap is designed to stop pensioners – who have already drawn down some or all of their pension – from receiving double tax relief by funding ongoing savings with their existing pension pots, which have often accrued without any taxation.’
The industry letter says: ‘When the limit was reduced from £10,000 to £4,000 in 2017, it was solely to curb the risk of income tax avoidance and the level was intended to be kept under regular review.
‘It was specifically intended not to affect those who accessed their pensions due to financial pressures such as divorce or redundancy.
‘However, the world is a very different place compared to 2017, with the UK suffering a cost-of-living crisis. Many over 55s have tapped into their retirement savings and are now restricted in their ability to rebuild these savings. ‘
It adds that possibly hundreds of thousands of workers over the age of 55 face an ‘older worker penalty’ that prevents them from saving for retirement and may discourage them from seeking work.
‘This is not good for them, or for the economy, or for the Exchequer, which is potentially missing out on millions of pounds of income tax and National Insurance revenue from their employment,’ the letter says.
Tom Selby, head of retirement policy at AJ Bell, says: ‘At the moment, anyone who flexibly accesses taxable income from their retirement pot has their annual allowance slashed from £40,000 to just £4,000.
‘They also lose the ability to “carry forward” up to three years of unused annual allowances from the three previous tax years.
‘Setting the MPAA at such a low level means even average earners making relatively moderate retirement saving contributions risk being hit with a tax charge.
‘This acts as a clear disincentive for people who want to return to work and keep saving for retirement. It also risks hindering those who have accessed their pension during a period of financial distress from rebuilding their pot afterwards.
‘Increasing the MPAA back to £10,000, the level at which it was originally introduced in 2015, feels like a no-brainer for Jeremy Hunt at this month’s Budget.
‘Over the longer-term, the Government needs to consider alternative mechanisms to control the risk of people ‘recycling’ tax-free cash.’
Helen Morrissey, head of retirement analysis at Hargreaves Lansdown, says: ‘Many people left the workforce during the pandemic and have yet to return with many older workers accessing their pensions to top up their income.
‘Many will wish to rebuild their pensions as they re-enter the workforce and the MPAA currently acts as a barrier to them doing so.
‘Increasing the level to £10,000, as set out in the letter, is a good first measure but longer term we need a wider look at pension tax relief and the MPAA’s role within it.’
She adds: ‘We have consistently called for the replacement of the MPAA with anti-recycling rules, which would treat contributions paid with the intent to recycle as an annual allowance excess and be taxed accordingly.’
‘A money purchase pension contribution would be treated as recycled if the contribution paid is significantly larger than it otherwise would be because of the pension withdrawal.’
Who signed the MPAA industry letter
‘This plea to raise the MPAA will be seen as opportunism’
Henry Tapper is a financial adviser and founder of the Pension Playpen professional network and AgeWage, which analyses the value for money of pensions. Here, he gives his take on the industry letter to the Treasury about the MPAA.
More than a dozen companies, including leading pension groups and trade associations, have urged ministers to change the rule that governs how much can be saved into a pension before tax charges apply.
The letter, signed by companies including Aegon, Canada Life and Fidelity, said the £4,000 threshold, known as the MPAA, is a ‘possible issue’ for hundreds of thousands of over-55s looking to return to work.
Henry Tapper: ‘There are so many injustices created in the pension systems; most of them fall upon those who are poorest’
What is the evidence of anyone over 55 finding they are losing tax-relief on contributions to pensions over £4,000 per annum – an issue for returning to work?
– A recent report by LCP – using ONS data – found that most of those out of work and over 55 weren’t working for health reasons – the MPAA is not their issue.
– The auto-enrolment contribution formula makes it impossible for anyone on standard contributions to contribute more than £4,000. The MPAA is an issue for those with highly paid, well pensioned jobs and then only a marginal one.
– Many sophisticated employers , contracting with highly paid employments have work rounds for the annual and money purchase allowance involving extra pay in lieu.
The wider issue is that many people are unnecessarily cracking into their pension pots and drawing out more than their 25 per cent tax-free lump sum to meet immediate needs.
This is allowed under the pension freedoms but it has tax consequences, immediate emergency taxation on the taxable portion of the withdrawal and the strictures of the MPAA going forward.
People who are raiding their pot are generally doing so for one of two reasons; either they are needy and have urgent need of relief on debt or they are greedy and want an extravagant Lamborghini lifestyle.
The needy are unlikely to be in a position to save £4,000-plus per annum in future, while the greedy are precisely those who the Treasury worry about getting double tax relief, through recycling contributions for personal fiscal gain.
This recycling is not victimless, it comes at the expense to the Treasury and ultimately is paid for by people who aren’t gaming the system.
Those signing this letter have yet to make a clear case for providing tax relief for those who have already overdrawn on their pot with full tax incentives.
The first thing Government will ask is whether this request is meretricious and self-serving. If it concludes that this is another attempt at special-pleading it will harden the hearts of civil servants and politicians and prove counter-productive.
There are so many injustices created in the pension systems; most of them fall upon those who are poorest – the net pay scandal, take up of pension credit, inheritability of the new state pension to name but three.
By comparison, the MPAA – a tax on privilege, is an incentive for the well-off to pay attention to the tax rules rather than be a pension Muppet.
If I was reading the letter as a Treasury official, I would treat it with contempt. This plea to raise the MPAA will be seen as opportunism, an attempt to make money out of the 700,000 elderly out-of-workers, most of whom are too sick to do productive employment.