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New analysis has shed light on how even people on moderate earnings could see their retirement plans damaged by the little-known Money Purchase Annual Allowance (MPAA).

The research from insurer Aegon concluded that people earning £30,000 a year would incur the MPAA penalty with monthly contribution rates over 13.4%.

The MPAA was first introduced alongside Pension Freedoms as a way to discourage people from withdrawing money from a pension pot and then recycling it into a pension scheme to claim further tax relief.

The reduced contribution limit is triggered when people flexibly access their defined contribution pension. Once started, the MPAA restricts the level of annual contributions to a pension to £4,000, down from the ordinary £40,000 annual allowance.

If contributions exceed £4,000 a year once the MPAA is triggered, a tax penalty is charged.

The MPAA becomes an issue for younger people because the minimum age to access your pension pot is 55, increasing to 57 in 2028.

With a growing number of people accessing their pension flexibly to support a more gradual transition to retirement and financial difficulties prompted by the pandemic creating financial challenges, the £4,000 contribution limit is under further scrutiny.

The analysis from Aegon shows it is easier than you might think to breach the MPAA limit of £4,000. Those on ‘moderate’ incomes of £30,000 a year who pay pension contributions based on their full salary will trigger the MPAA with pension contribution rates over 13.4%.

This contribution rate required to breach the £4,000 annual contribution limit falls to 8% for those earning £50,000 a year.

While some pension schemes base contributions on total earnings, others use ‘qualifying earnings’, a band of earnings between £6,240 and £50,270.

Based on qualifying earnings, people earning £30,000 a year will reach the £4,000 contribution limit with a pension contribution of 16.9%, falling to 9.2% for someone earning £50,000 a year.

Steven Cameron, Pensions Director at Aegon, said:

“The last 18 months have seen many individuals face difficult decisions as the coronavirus has left a damaging toll on personal finances. Those over 55 who have lost their job or faced reduced wages, may have been tempted to dip into their pension to access financial support during the crisis. But the ability to access pension savings flexibly comes with a sting in the tail as it triggers the little-known money purchase annual allowance (MPAA), which limits any future pension contributions to just £4,000 per year, one tenth of the standard £40,000 limit.

“Aegon’s analysis shows that even those on moderate incomes are at risk of breaching the MPAA. Someone earning £30,000 per year and paying pension contributions on their full salary will breach the limit with monthly contributions over 13.4%, and this includes any contributions from their employer. Savers, therefore, need to have their eyes wide open when accessing their pension to avoid devastating consequences on future retirement plans.

“The pandemic has highlighted the need for greater flexibility and we’re calling on the Government to increase the MPAA to ensure people who have been adversely affected by the crisis are not left disadvantaged in their ability to rebuild their pension savings. Increasing the MPAA limit to at least £10,000 would go some way to help those individuals whose retirement plans have been thrown into disarray.”

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