In a previous article you say that someone taking income from a defined benefit pension could still contribute to their SIPP up to the level of their earnings. Does this mean that the money purchase annual allowance of £10,000 applies only if you take taxable income from a defined contribution scheme and not from a defined benefit scheme?

Similarly, if I have two defined contribution schemes and take taxable income from one scheme does the money purchase annual allowance then apply only to the scheme from which I drew taxable income or to both schemes?

Charles

Rachel Vahey, AJ Bell Head of Public Policy, says:

When pension freedoms were first introduced almost 10 years ago, pension savers were given the flexibility to take as much money out of their defined contribution pension pot as they wanted. But at the same time, the government was concerned people could simply take their money out of a pension and then reinvest it back, gaining tax relief and building up further 25% tax-free cash.

To reduce the opportunity to do this, HMRC tightened up the rules on recycling of tax-free cash, as well as introducing the MPAA (money purchase annual allowance).

As a reminder, the annual allowance, currently £60,000, is the maximum amount of pension savings that can be made each year (both by the individual and their employer) with the benefit of tax relief. As well as that, an individual’s contribution (including the 20% tax relief paid by HMRC) cannot be more than 100% of their earnings in that tax year.

EXPLAINING THE MONEY PURCHASE ANNUAL ALLOWANCE

The MPAA is another allowance within the annual allowance. It restricts the contributions that can be paid into all your money purchase pensions – for example SIPPs - if you have started taking a flexible income. It reduces the limit from £60,000 to £10,000 each tax year and applies to your total contributions across all money purchase pensions – even if you only took one ‘flexible income’ payment from any one of them. Additionally, it is not possible to make use of any unused contribution allowance (known as carry forward) from previous tax years to increase this amount.

The MPAA is ‘triggered’ if you ‘flexibly access’ your money purchase pension pot. For example, if you take a taxable amount from your drawdown plan, or you exceed your income limit in capped drawdown or you buy a ‘flexible annuity’ that allows income to fall.

It wouldn’t be triggered if you took tax-free cash but no taxable income from your drawdown pot, or if you bought a ‘lifetime’ annuity, or if you took an income or a lump sum from a pension pot you had inherited from another person. Nor would the MPAA be triggered if you took taxable income from only a defined benefit scheme.

The MPAA only applies to all contributions to money purchase schemes made after the date it’s triggered. So, if you started to take a taxable income half-way through the tax year then it would only apply to contributions paid into your SIPP after that date. (Although the total contributions for the year are still tested against the £60,000 annual allowance.)

If you also have a defined benefit scheme (this may also be referred to as a final salary or career average scheme) you can continue to build up benefits worth up to £60,000 a year in total (depending on how much you pay into your money purchase pension), plus any unused allowance from the previous tax years, across all your pensions without facing tax charges. But the amount that is contributed to all your money purchase pensions must not exceed £10,000 or you’ll have to pay tax charges.

The amount you can contribute to a defined benefit scheme in these circumstances is called an ‘Alternative Annual Allowance’.

HOW IT COULD WORK IN PRACTICE

A simple example may help to explain this. Sam takes his tax-free cash from his SIPP, as well as a taxable income of £18,000 a year. He carries on paying in £5,500 a year into his SIPP as well as being an active member of his defined benefit scheme. The amount he can build up in his defined benefit scheme is restricted to £54,500 for the tax year.

Working out this ‘Alternative Annual Allowance’ for a defined benefit scheme can be quite tricky, as you have to work out how much an increase to your defined benefit pension is worth in monetary terms. (Whereas it can be quite simple to see how much you are paying into a SIPP.)

So, if you have any questions it may be worth asking your employer and pension scheme administrator, or a regulated financial adviser, for some help.  

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