Why the hike in the MPAA is good news for pension savers

Why the MPAA?

The money purchase annual allowance (MPAA) was introduced as an anti-avoidance measure to limit a tax loophole, known as recycling, created in 2006 and widened by pensions freedom in 2015. Recycling involves using the tax-free cash that can be taken from all pensions schemes (when you reach 55) to fund another pension plan and claiming tax relief on the new investment. In effect, obtain double income tax relief.

MPAA limits

The MPAA limits recycling by reducing the amount of pension contributions which qualify for tax relief. Instead of the usual annual allowance (AA) limit of £60,000 (£40,000 before 6 April 2023), the MPAA caps tax relief to contributions of £10,000 per year. While recycling is possible the tax advantage gained from it is relatively modest. However, although the MPAA was originally set at £10,000, between April 2017 and April 2023 it was slashed to £4,000. This had two consequences: :

• tax-free cash recycling was barely worth the effort; and
• it created a trap for many individuals who had already or subsequently taken advantage of the pensions freedom the government introduced just a couple of years earlier in 2015.

The MPAA trap

Where the MPAA is triggered, i.e. by flexibly accessing some of your pension savings from a money purchase type pension scheme, and contributions to your pension savings for a tax year exceed the MPAA, the excess counts as taxable income. This is known as an AA charge. Where you pay more than this into a pension the effect is no more than to claw back the tax relief you receive on it. However, there’s a bigger problem. 

The AA charge applies even where someone else, e.g. your employer, pays the contributions for you and receives tax relief for them. You can be liable to an AA charge to claw back tax relief by someone else, e.g. your employer. This has become a major problem for employees with a workplace pension as these require employers to pay contributions for their workers.

Example. Harry is a director of Acom Ltd. He’s a member of its workplace pension and also has a personal pension plan. Harry is subject to the MPAA. His contributions to Acom’s workplace scheme for 2022/23 were £4,000 and Acom’s £3,000. In addition Harry paid £2,000 into his pension plan. He received basic and higher rate tax relief of £2,400 (£6,000 x 40%) on his contributions. Of this £800 is excessive ((£6,000 - £4,000 MPAA) x 40%). Harry must declare this AA charge on his self-assessment tax return for 2022/23. He must also declare an AA charge of £1,200 (£3,000 x 40%) on the £3,000 his employer paid but for which Harry received no tax relief. The increase in the MPAA to £10,000 is great news for Harry. While it won’t help him for 2022/23 it will eliminate the AA charge for 2023/24 and later years assuming his pension and Acom’s pension contributions stay at the same level as 2022/23.

Recycling is a good thing

Apart from reducing the AA charge, for many taxpayers the increase in the MPAA will again make the tax advantages from pension recycling worthwhile.