27 Apr Pension changes
Jeremy Hunt’s March 2023 budget made some important changes to pensions, some of which were kept under wraps until the actual speech and only appeared afterwards in the ‘small print’.
Most of you will have read or seen the headline changes but here is a summary of the main points and some of the details not announced in the speech.
From 6th April 2023, the annual yearly allowance for tax relief when funding pensions increased significantly; by 50% to £60,000. This enables anyone not classified as a ‘high’ earner to receive and contribute more into their pensions and will also help those in defined benefit schemes who previously incurred an annual allowance tax charge due to their deemed annual input as the value of their benefits increased.
The money purchase annual allowance (MPAA) and the minimum tapered annual allowance (TAA) were both increased from £4,000 to £10,000. The MPAA limits the available tax relief on pension contributions for those who have previously accessed their pension benefits using certain flexible methods. The TAA targets ‘high’ earners by reducing the amount of tax relief that they can claim on pension contributions.
The adjusted income threshold for a ‘high’ earner has been raised from £240,000 to £260,000. This and the increase of the TAA to £10,000 provide more scope for individuals with high taxable income to continue to make or receive gross pension contributions of up to £10,000 per tax year.
Perhaps the most surprising announcement was that the lifetime allowance (LTA) was abolished altogether. Prior to the budget, it was anticipated that it might be increased but not many predicted that it would be removed altogether.
This means there should be no additional tax charges on drawing benefits from pension schemes whose value exceeds the previous LTA of £1,073,100.
The post-budget documents confirm that while the tax charge for breaching the allowance was removed from 6th April 2023, the LTA itself will not be abolished entirely until 6th April 2024. The tax charge for exceeding the LTA in the current tax year will be at a rate of 0%.
This means that people previously unable to make pension contributions, either due to the value of their benefits exceeding the LTA or because they would have lost various LTA protections, can now make contributions without the possibility of an LTA tax charge.
Pension commencement lump sums or tax-free cash
This, you may think, means that the various forms of protection (enhanced, primary, fixed or individual) that provided a higher LTA for certain individuals are no longer relevant. However, for pension commencement lump sums (PCLS), some of these protections are still important. This is why it was important for those individuals with existing protection (enhanced or fixed) which precluded further benefit accrual to pay attention to the details and not rush to make pension contributions between the budget and the end of the last tax year.
PCLS, or tax-free cash as it used to be known, was restricted to 25% of the pension fund value (or deemed benefits value if a defined benefit scheme) or 25% of the LTA (or protected LTA) if lower. The only exceptions were scheme-protected PCLS entitlements from before 6th April 2006.
The available tax-free sum will now be capped at £268,275, being 25% of the last LTA. Therefore, even though the LTA is being abolished, its legacy still applies to the maximum PCLS that people can take from their total pension benefits. There is currently no indication that this easy to remember amount will be index-linked and, therefore, it seems that it will reduce in real terms over time.
However, for those with existing protections, their existing higher protected PCLS will be retained as long as the protection was applied for before 15th March 2023.
Even with the likelihood of a reducing PCLS in real terms, pensions remain a tax-efficient way to make long term savings as they will continue to attract tax relief at the member’s highest marginal rate of tax. Enabling compound growth on tax-efficient savings and with planning on how income benefits are taken, a lower rate of income tax may be payable when benefits are taken.
The new LTA rules changes may benefit individuals in the following specific situations:
- For individuals who were likely to exceed the LTA of £1,073,100 it may now be appropriate to keep saving into pensions.
- Anyone who has used their LTA and has excess funds that are yet to be taken or tested against the LTA may be able to draw these benefits now without a tax charge.
- Those with defined benefit (final salary) pensions and defined contribution (money purchase) pensions who previously were likely to exceed the LTA. They should no longer have to make a choice of which benefits to take first and whether a lump sum could be taken within the LTA, reducing their guaranteed pension.
Anyone now thinking of accessing their pension benefits before these rules are changed again to release the excess funds over the lifetime allowance should take appropriate advice first and do so as part of a holistic financial plan.
Pensions will continue not to form part of one’s estate for inheritance tax (IHT) purposes. Therefore, drawing pension benefits and then having the funds in your estate and becoming subject to IHT at up to 40% may not be sensible. This continues to be a complicated part of pension and estate planning and advice from a professional should be obtained.
Word of warning
The Labour Party has already stated that it will reverse these changes if it wins the next general election. Therefore, these changes may only apply for a short period of time and action may or may not be needed before the next election.
While the latest changes may indeed be a simplification of the most recent pensions regime, we saw what happened the last time pensions were simplified in 2006 and that didn’t end up entirely as originally proposed, even if some of the worst complexities were subsequently removed.
Whatever your current pension situation, you may benefit from advice in the context of a financial plan based on your values and objectives.
This blog is intended for information purposes only and no action should be taken or refrained from being taken as a consequence without consulting a suitably qualified and regulated person. Your capital is at risk when investing. Past performance is not a reliable indicator of future results and forecasts are not a reliable indicator of future performance.
Please note that this does not constitute tax advice and any comments or observations on taxation are merely to provide general guidance. You should therefore take appropriate tax advice from a qualified tax adviser as tax treatment depends on an investor’s individual circumstances and may be subject to change.