Some of you out there may be a bit long in the tooth, like myself, and withdrawn their 25% tax-free lump sum from a pension scheme.
If so, you should be aware of the Money Purchase Annual Allowance (“MPAA”) which was introduced in April 2017 to counter perceived tax avoidance, pension “recycling”.
So, what is recycling? This is when you take some or all of the tax-free element of your pension savings and reinvest it into a new pension plan. The new contribution qualifies for tax relief and generates an entitlement to a new tax-free lump sum. In effect, you’re using your original tax-free payment to create more tax-free income at no extra cost. How good is that? Well, apparently too good for the wicked taxman (BOO, HISS …… Well it is pantomime season, after all)
So, what is the MPAA? This caps tax relief on future pension contributions to £4,000 per annum in most situations where you’ve arranged to draw money from your pension scheme after April 2015, and then made the withdrawal. The cap means that tax relief you receive for pension contributions in excess of £4,000 per year is clawed back through the annual allowance charge. Also, if the nasty man from HMRC considers that you’ve exceeded the limits for recycling pension contributions, then he may impose very stiff financial penalties (HE’S BEHIND YOU!!)
There are two more points to make. Firstly, both your own and your employer’s contributions into an auto-enrolment pension scheme count towards the £4,000 per annum limit on contributions. Secondly, Mr Nasty Taxman cannot impose any penalties for exceeding the limits unless you’ve received more than £7,500 tax-free pension cash in the previous 12 months AND increased your pension contributions by more than 30%, ie penalties will only be applied in the most flagrant cases of breaches of the rules (PHEW!! HURRAH!!).
So, given the above is it worth even considering? Well, provided that you avoid paying contributions at a rate that triggers a penalty, reinvesting at the £4,000 per year maximum allowed by the MPAA can build a substantial extra tax-free lump sum. Assuming an annual growth rate for your fund of, say, 5% per year, annual recycling could generate an extra £13,000 tax-free cash over ten years. The bottom line is that just because you have or are taking money from your pension savings this doesn’t prevent you from continuing to build another tax-free lump sum.
And now for the legal bit (BOO). WatkinsonBlack are not authorised to give pension advice. The above is not intended to provide pension advice but solely to consider the tax implications of pension contributions.
For details of when the penalties apply and the calculations behind the example, visit http://tipsandadvice-tax.co.uk/download (TX 19.04.03).