Millions of people will save into a pension with the hopes of securing a solid income for a comfortable retirement. However, despite the benefits of this savings method, there are some important tax rules to consider.
If Britons fail to heed them, it could spell disaster for their retirement and savings potential.
With this in mind, Express.co.uk spoke to James Jones-Tinsley, self-invested pensions technical specialist, at Barnett Waddingham.
He unpacked a key issue Britons will need to look out for in 2023 as it relates to tax.
Being aware of this matter could save individuals from a hefty and unwelcome tax bill this coming year.
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“However, if you access taxable income from this pension pot, rather than just the available tax-free cash sum, you will automatically trigger MPAA.”
The MPAA could have a serious effect on what Britons can save in the future towards their pension.
The expert continued: “This means that, going forwards, the maximum amount that you (and your employer, if you are still working) will be able to contribute to a money purchase pension, will be limited to a maximum of £4,000 gross per tax year.
“This is significantly lower than the ‘normal’ annual contributions allowance of £40,000 gross per tax year.”
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The 90 percent annual allowance cut could be a shock for those hoping to use their pension as the main way to save for retirement.
However, there may be ways for Britons to avoid the MPAA, and thus not fall into the tax trap.
One particular rule a person might be able to take advantage of is the small pots rule – which is not widely known.
Small pots rules allow people to make taxable withdrawals while retaining their full allowance annually, in some circumstances.
A small pot is defined as a pension which is worth £10,000 or less, which many may have from a short-lived or part-time job.
However, according to AJ Bell, in order to class as a small pots withdrawal, a person must “extinguish the entire pension pot you are accessing”.
Some may wish to consider only taking their 25 percent tax-free cash from their pension to avoid the risk of triggering the MPAA.
To do so, Britons will need to “crystallise” some or all of their pension, which involves choosing a retirement income route – either drawdown or annuity.
MoneyHelper, the Government-backed service, has explained two instances where the MPAA is not normally triggered.
The tax trap won’t be set off if:
- A person takes a tax-free cash lump sum and buys a lifetime annuity that provides a guaranteed income for life that either stays level or increases
- A person take a tax-free cash lump sum and puts their pension pot into flexi-access drawdown but doesn’t take any income from it.