An Express reader who returned to work at age 70 has discovered their annual pension allowance has been slashed to £10,000 due to a previous annuity decision. The reader, who took out a five-year fixed-term annuity with a guaranteed lump sum, now faces an unexpected tax hit on contributions above this limit.
Why the allowance is reduced
Charlene Young, head of technical at AJ Bell, explained that a lifetime annuity pays income for life and does not trigger the money purchase annual allowance (MPAA). However, flexible or short-term products, including many fixed-term annuities, do trigger the MPAA. This flexibility is the crucial difference, despite both carrying the annuity label.
Once triggered, the MPAA reduces the annual allowance for money purchase schemes to £10,000 per year. Payments above this amount in a tax year face a tax charge, and unused allowance cannot be carried forward. The MPAA cannot be reversed, even when the fixed-term annuity matures or if a lifetime annuity is purchased later.
Tax implications and options
The annual allowance tax charge applies to contributions above £10,000, at the reader's income tax rates, even if made by an employer. With income over £100,000, the tax-free personal allowance reduces by £1 for every £2 over the threshold, creating an effective tax rate of 60% on income between £100,000 and £125,140.
Young suggests reviewing the salary sacrifice arrangement, reducing working hours, or reducing income from flexible drawdown pensions. Deferring the state pension offers an uplift of around 5.8% per year, but it takes over 15 years to break even. Investment products with up-front tax relief involve high risk and may not be suitable.
The reader is advised to consult a financial planner for personal guidance.
