Don’t sweat the small stuff – the proposed reduction in the MPAA
You have to admit it was a bit of a throw away line by the Chancellor, he hardly even paused for breath when he said the money purchase annual allowance (MPAA) was to be reduced to £4,000 from April 2017. In the accompanying consultation document from the Treasury, it is stated that “the government does not consider that earners aged 55+ should be able to enjoy double pension tax relief i.e. relief on recycled pension savings”.
I thought we already had legislation to stop this occurring; it’s commonly known as the recycling rule. Ah, I hear you say, but one of the conditions for this to apply is that the Pension Commencement Lump Sum (PCLS) has to be greater than £7,500, and there is no need to take an income from the resulting drawdown fund, for instance, therefore the MPAA is not triggered simply by taking the PCLS. I fully accept this, but consider the following scenario in line with other comments made in the consultation, and bearing in mind taking any more than a £7,500 PCLS, potentially triggers the recycling rule.
An additional rate tax-payer takes an Uncrystallised Funds Pension Lump Sum (UFPLS) of £10,000 with the intention of reinvesting the proceeds back into their pension to leverage the tax relief. To keep things simple let’s presume they then immediately crystallise the reinvested amount. Taking a UFPLS triggers the MPAA.
Due to the way tax relief through relief at source operates, to maximise the leverage and create the second UFPLS of £12,045, the individual would have to make a net contribution of £9,636. In the short term, they would have to find an additional £3,011 over and above the £6,625 net amount paid from the first UFPLS. This action results in a second net UFPLS of £7,980, but factoring in the already mentioned £3,011, means the short term net amount is only £4,969. Taking just the first step, the individual has a net positive cashflow of £6,625, compared to the short term amount of £4,969 in carrying out the whole exercise; a lower figure by £1,656.
That aside, the differential between the £7,980 and £6,625 is £1,355 which seems not a bad return for no additional cost. However by way of comparison, to gain the equivalent in tax relief an additional rate taxpayer only has to make a gross contribution of £3,011, and given that the MPAA will severely restrict any future pension planning for the individual, even allowing for potential tapering of the annual allowance, it begs the question, why bother for so little real ‘return’, particularly as the individual will also suffer an Annual Allowance (AA) charge on the excess of £2,045 (they triggered the MPAA on the first UFPLS) of £920.
Over and above the triggering of the MPAA and the AA charge, the individual may be out of the market for a number of weeks while the UFPLS is paid and then reinvested, and given the volatility of the market at the moment, by simply remaining invested they could have gained a few extra percentage points of growth. In addition they will also have the pension provider’s transaction fees to factor in if they carry out this exercise, plus possible adviser fees, and perhaps more importantly, given the continuing erosion of the Lifetime Allowance (LTA), also use up some of their valuable LTA for little in the way of gain. All of which further reduce the efficacy of the exercise.
If the Chancellor wants to clamp down on individuals who arbitrage the pension freedoms, then bring in legislation that impacts on those who are concurrent members of final salary and other money purchase arrangements. Those individuals can flexibly access their other money purchase arrangement, trigger the MPAA, but still retain the full £40,000 AA for their final salary pension savings, as long as they do not make further contributions to the money purchase arrangement. Given that a number of these individuals will be senior employees in public sector pension schemes, I won’t be holding my breath!