New pension tax rules- changes to the Annual and Lifetime Allowance
This article was published in March 2023
Jeremy Hunt’s March 2023 budget did not contain many surprises. Prior announcements, leaks and educated guesses meant most facets of budget broadly met expectations. However, the planned changes to pensions, particularly the decision to remove the lifetime allowance, were kept well-hidden. This was most likely due to the predictable response from across the benches.
Aims
The budget measures can be seen largely in response to the drain on the NHS of senior staff such as doctors, consultants, dentists and nurses. Many were increasingly becoming disincentivised to continue working given punitive tax charges on both accruing and drawing their pension benefits.
The Annual Allowance
From April 2023 the annual yearly allowance for tax-relieved funding of pensions is increasing significantly by 50% to £60,000.
Further measures include increases to the money purchase annual allowance (MPAA) and the minimum Tapered Annual Allowance from £4,000 to £10,000. These limits sought to reduce the available tax relief on pension contributions for those who had accessed their pension benefits in certain ways and for higher earners respectively.
The definition of a high earner will also be raised from £240,000 to £260,000. The definition of such earnings is complicated. Broadly, it is gross income from all sources plus any pension contributions made by one’s employer.
The Lifetime Allowance
The announcement that generated the greatest furore in the Commons was that the lifetime allowance was being abolished altogether. This means there should be no additional tax charges on withdrawing from pension funds over the current cap of £1,073,100. A raft of transitional provisions that provided a higher lifetime allowance for certain individuals have been removed (with one key exception, discussed below).
In simple terms, this will allow many people much more scope to save into pensions than had previously been the case. This includes those with a protected lifetime allowance who have been unable to contribute further without losing this protection and incurring substantial tax charges as a result.
It is worth noting that it takes time to enact the relevant legislation, with the removal of the lifetime allowance to be introduced from 6 April 2024. Therefore, from 6 April 2023, the lifetime allowance will still apply but will be ‘nil-rated’. This means that even though the lifetime allowance charge could, in theory, arise, it should not actually result in a charge.
Tax-Free Lump Sums
However, there is a catch. Currently, 25% of pensions can be taken tax free, with the rest taxed as income. This available tax free lump sum is to be capped at £268,275, or 25% of the current lifetime allowance. Essentially, the lifetime allowance has changed, but the maximum tax-free cash people can take from a pension has not. There is no suggestion, yet, that this will be index-linked, potentially representing another form of stealth tax. Those with a protected lifetime allowance should continue to benefit from the higher level of tax-free lump sum their protection implied.
However, this should not greatly detract from the value of pensions, which generally aim to provide tax relief at a higher marginal rate of tax when one is earning and saving, and paying a lower rate of tax when drawing benefits. In the meantime, the funds grow free of income and capital gains tax and should generally be outside of one’s estate for inheritance tax purposes.
Implications
These changes will not affect the majority of the population but may have significant implications for those who are at, or are predicted to hit, the current lifetime allowance of £1,073,100. For this group, where before it was not advisable to put any more than the cap into their pension, now they can keep saving indefinitely and still take their pension as normal.
There are likely to be a number of benefits for certain groups of people, although the detail of the legislation will need to be better understood first. For example, those who have used their lifetime allowance and had excess funds that were yet to be charged, may be able to draw these benefits now without penalty.
The change in the rules may also benefit those with both defined benefit (final salary) pensions and defined contribution (money purchase) pensions who were exposed to the lifetime allowance. In the broadest terms, such people may have had to choose between taking their valuable, guaranteed final salary pension and giving up their available tax-free lump sum or preserving the tax-free lump sum and giving up valuable pension benefits. The fine print remains to be seen, but this could be a boon for those affected who may just have their cake and eat it.
Those wishing to access their pension benefits in full sooner rather than later to release the excess funds over the lifetime allowance should only do so with caution and taking advice first. Pensions do not generally form part of one’s estate for inheritance tax purposes. Therefore, by bringing pensions back into one’s estate by withdrawing them, the funds may be subject to inheritance tax at up to 40%. The rules around this and taxation of death benefits are more complicated than this and are beyond the scope of this article. However, in part, this will usually depend on the tax position of beneficiaries, certainly for those who have survived age 75.
Conclusion
We welcome these changes which, apart for the obvious tax savings, significantly reduces complexity. However, Labour have already stated that they will reverse these changes if they win the next general election.
Therefore, we may be looking at a transitory period and a window of opportunity as a worst-case scenario, but possibly the longer-term simplification of the overly complicated pensions’ system.
In all likelihood the complexity and change that has plagued the UK pension system will continue, but the current changes seem to be a step in the right direction.
Disclaimers
This document is based on our initial understanding of the changes arising to pension arrangement from the 2023 Spring Budget and some of the potential implications. We cannot be exhaustive in the detail provided. This document should not be taken as advice, or a personal recommendation, and you should discuss the implications with your Financial Adviser. We await further details in the forthcoming Finance Bill. Tax and legislation are subject to change in the future.
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