Warning for people who make small withdrawals from their pension
Savers could see their annual allowance – the amount they can contribute to their pension each year – fall from £40,000 to just £4,000 if they draw money from the “wrong pot”, according to insurer Royal London.
The firm says people with more than one pension pot who want to withdraw less than £10,000 should consider cashing in their smaller pot in full rather than taking a partial withdrawal from a larger pot.
When someone makes a small withdrawal from a large pension, it triggers something known as the Money Purchase Annual Allowance (MPAA), which is the maximum savers can contribute to their pension each year once they’ve started withdrawing taxable money from their pot.
The MPAA is £4,000, significantly less than the standard £40,000 annual allowance savers can contribute to a pension.
Typically, someone taking money out of a defined contribution pension is affected by the MPAA if they take out more than the 25 per cent tax-free lump sum.
But under a little known rule, those who take everything out of a ‘trivially’ small pension pit under £10,000 do not trigger the MPAA.
Steve Webb, director of policy at Royal London said: “Last year, over half a million people aged 55 or over made flexible withdrawals from their pension, and many of these withdrawals will have been for amounts under £10,000.
“If they emptied out a small pot then this will have had no impact on their future ability to save into a pension. But if, by mistake, they took the same amount as a partial withdrawal from a bigger pot, they risk triggering stringent HMRC limits on future pension saving.
“Those with more than one pension pot should consider very carefully the order in which they access these funds, especially if they may want to contribute into a pension in future”.
Why was the MPAA introduced?
Since the pension freedom rules were introduced in April 2015, savers aged 55 and over have been allowed to take money out of their pension in chunks rather than turning the whole pension pot into an income for life by buying an annuity.
To stop people from repeatedly taking money out, benefiting from tax free cash, and putting money back in again with the benefit of tax relief, HMRC introduced a limit on the amount people could put back in pensions once they had started drawing taxable cash – known as the MPAA.
It was originally set at £10,000 a year but is now £4,000.