Revealed: 3 pension allowances you need to be aware of
The aim of your pension contributions is to amass a pot of money that allows you to live your desired lifestyle in retirement. With a long-term financial plan in place, you should be well on your way to realising this goal.
But the UK pension system is complex. It includes allowances, tax charges, and triggers that you need to watch out for. Understanding how close you are to a given threshold, which allowance applies to you, and the consequences of exceeding a given limit is crucial.
Here’s your guide to the pension allowances that apply to you.
The Lifetime Allowance
- What is the Lifetime Allowance?
The Lifetime Allowance (LTA) is the amount you can withdraw from your pension without triggering an extra tax charge.
The LTA amount rises each year in line with the Consumer Prices Index (CPI). For the 2020/21 tax year the LTA is £1,073,100, rising to £1,078,900 from 6 April 2021.
- How and when am I tested against it?
Your benefits are tested against the LTA when you access your pension in certain ways. These are known as Benefit Crystallisation Events (BCEs). There are currently thirteen BCEs, which means thirteen ways to take your pension that will result in a test being carried out.
These include designating pension funds to drawdown, purchasing an annuity, reaching age 75 (the birthday itself is not an event but a BCE will always have been triggered by at least age 75), taking a Pension Commencement Lump Sum (PCLS) or Uncrystallised Fund Pension Lump Sums (UFPLS), or transferring your pension overseas.
This not an exhaustive list, but we can help you identify when you might become liable for a test and help you to plan accordingly.
- How much is the Lifetime Allowance charge?
The LTA charge payable depends on what you are doing with the funds that exceed the allowance.
Broadly, you will be charged 55% for taking the excess amount as a lump sum, and 25% if you opt for income.
You may have HMRC LTA protection in place. If not, or if you are unsure, be sure to speak to us as you near the LTA limit. We can help you put a plan in place to mitigate the impact of any charge.
The Pensions Annual Allowance
- What is the pension Annual Allowance?
The pension Annual Allowance is the amount you can contribute to a pension each year while still receiving tax relief.
For the 2020/21 tax year, it stands at £40,000 (or up to 100% of your earnings if lower).
Pensions are tax-efficient and the best way to take advantage of that is to make full use of your Annual Allowance each tax year if you can afford to. You can also carry unused allowance forward for up to three years.
Get in touch and we can help you calculate the allowance you have left, as well as the level of any unused allowance from previous years.
Be aware that if you are a high earner, or you have already accessed taxable Defined Contribution (DC) pension benefits, the Annual Allowance that applies to you might be different.
The Money Purchase Annual Allowance (MPAA)
- What is the MPAA?
The MPAA is a reduction to your Annual Allowance that comes into force if you ‘flexibly’ access taxable DC benefits, such as by taking an Uncrystallised Fund Pension Lump Sum (UFPLS).
It is intended to stop potential recycling that would occur if flexibly accessed benefits were re-contributed, thereby benefiting from tax relief for a second time.
- What does triggering the MPAA do?
Once the MPAA is triggered it reduces your Annual Allowance from £40,000 (or up to 100% of your pensionable earnings if lower) to £4,000.
You can only contribute £4,000 a year into your pension and still benefit from tax relief.
If you are looking to take pension benefits early using Pension Freedom rules, but also want to continue paying into your pension, you must understand the consequences of triggering the MPAA. Speak to us if you’re unsure of the impact the MPAA might have on your retirement plans.
- What does and doesn’t trigger the MPAA?
The MPAA will trigger if:
- You take a UFPLS (either your whole pot or through a series of separate withdrawals)
- You access Flexi-Access Drawdown income.
You won’t normally trigger the MPAA if:
- You access tax-free cash only
- Take a Pension Commencement Lump Sum (PCLS)
- Designate funds to drawdown but do not take income them (even if you take tax-free cash)
- Take a small pension pot lump sum.
Again, this isn’t an exhaustive list, so get in touch if you’re worried about triggering the MPAA.
The Tapered Annual Allowance
- What is the Tapered Annual Allowance?
The Tapered Annual Allowance lowers the Annual Allowance for high earners. If you earn over a certain threshold amount, your £40,000 allowance will decrease by £1 for every £2 your income exceeds that amount.
- What is the earnings threshold?
There are two earnings thresholds to consider. If you exceed both, you will trigger the taper and your Annual Allowance will decrease.
The two measures are ‘threshold’ income and ‘adjusted’ income. Threshold income is your taxable income, such as salary, bonuses, and pension. Adjusted income is broadly the same, except that it also includes employer pension contributions.
For the 2020/21 tax year, the threshold income is £200,000. Exceed that and you’ll need to calculate your adjusted income. If that exceeds £240,000 then the taper applies.
- What is the maximum taper?
The taper decreases your Annual Allowance by £1 for every £2 that your adjusted income exceeds the limit, down to the minimum tapered allowance of £4,000 (in line with the MPAA).
This will apply to those earning over £312,000 a year, but the calculations can be complex – especially where your income can fluctuate – so speak to us if you’re unsure.
Get in touch
Keeping on top of pension allowances can be difficult, but the penalties for exceeding or triggering certain thresholds can be long-lasting.
Please get in touch if you’d like to discuss your retirement plans or if you have any questions about any pension allowances or potential trigger events.
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