The Chancellor of the Exchequer, MP Jeremy Hunt, spoke to the House of Commons last week and emphasised his belief that strict pension tax rules were negatively impacting the UK labour market (for example, by driving senior doctors out of the NHS). Mr Hunt subsequently announced several measures to help tackle this issue as part of his Spring Budget 2023. The announced changes to pensions tax apply to all pension savings and will apply from the 2023/24 tax year. These measures are the most dramatic changes to pensions tax in almost a decade and we explore the key proposed changes to pension tax rules in this article.
Abolishing the lifetime allowance
Under the current rules, there is a specified maximum amount of saving that an individual may make in a registered pension scheme without incurring a tax charge known as the lifetime allowance (LTA). For the 2022/23 tax year, the standard LTA[1] was set at £1,073,100. Any pensions savings above the standard LTA are taxed at 55% if the money is taken as a lump sum or, alternatively, 25% on top of income tax if taken out gradually.
The Chancellor was expected to raise the LTA cap in his Spring Budget 2023 but he made the surprise announcement that the LTA charge will now be removed from 6 April 2023 and will be completely abolished from April 2024 under a future Finance Bill. This means that over the course of their employment, workers can contribute into their pensions scheme (and benefit from government tax relief) without incurring a penalty for exceeding the LTA. Financial and actuarial consultants Lane Clark & Peacock LLP have predicted that this could boost the pension savings of more than one million pensioners and that taxpayers will save £2.75 billion over the next five years when the LTA is abolished.
Tax-free lump sum
Under the pension tax rules, an individual can usually take up to 25% of the amount built up in any pension as a tax-free lump sum. While the LTA is being eradicated, Mr Hunt’s announcement means that the tax-free lump sum that workers can access from their pensions at the age of 55 will remain capped at £268,275. Anything above this sum will be subject to income tax and the cap will be frozen at £268,275, meaning it will potentially lose its value over time due to inflation. Although we are waiting further detail in relation to the announced changes, it is presumed that those who are afforded enhanced tax protections will be able to retain a higher tax-free lump sum subject to the current conditions. The cap remains in the hope that it will put workers off retiring as early as 55 and is part of the government’s wider strategy to entice people to remain in the workforce for longer.
Annual allowance
The annual allowance is a restriction on the amount of tax-relieved pensions savings an individual can make each year. If the value of contributions exceeds the annual allowance, a charge to income tax usually arises. Working overtime can therefore trigger large, unexpected tax bills for workers which results in workers reducing their hours or retiring early. This has particularly been the case for NHS doctors, whose services are in high demand.
In his announcement, Mr Hunt said that the annual allowance for most people will increase from £40,000 to £60,000. The impact of the tapering of the annual allowance[2] is also being reduced and will now apply to members with income of more than £260,000, compared to £240,000 currently. The lower limit will also increase to £10,000 in the next tax year. People who may have limited their pension contributions now face the prospect of being able to significantly boost their retirement wealth with these changes to the annual allowance.
Money purchase annual allowance
If a member of a defined contribution pension scheme takes money from their pension pot, the amount that can be contributed to their defined contributions pension whilst still getting tax relief might reduce. This is known as the money purchase annual allowance (MPAA). Under the current rules, most people receive tax-relief on £40,000 worth of pension contributions (due to increase to £60,000 as discussed above) but if MPAA is triggered, then this sum reduces to £4,000.
The government had announced that the current restriction of £4,000 will now be increased to £10,000. This hopes to give people who have previously accessed their pensions as a result of the greater pension freedom. It is important to note that the MPAA only applies to contributions to defined contribution pensions and not defined benefit pension schemes.
Conclusion
The announced changes will have an impact on workers and employers alike. For example, many organisations use an “excepted life” policy to provide life cover for employees where the LTA has been an issue. Excepted group life insurance schemes provide lump sum death benefits outside the registered pension scheme environment. Therefore, any benefits paid are not included in the calculation of the LTA. The operation of these policies may need to be considered as the abolition of the LTA may make “excepted life” policies redundant. Employers will also need to consider the implications of the changes on any offering for cash in lieu of pension contributions for 2023/24.
The government’s proposal has been met with some opposition and alternatives have already been put forward, such as a suggestion to replace the LTA with a “targeted scheme” for doctors. With an election looming, this creates material uncertainty and is something to keep a close eye on in the near future.
To get in touch with one of our pensions experts for advice on the new rules, or for any other pension queries, please contact Eleanor Hart (eleanor.hart@dentons.com).
[1] There are various forms of tax protection available to some individuals which increase their LTA above that of the standard LTA. References in this article to the LTA are intended to mean the standard LTA.
[2] Higher earners are impacted by the tapered annual allowance. This gradually reduces the amount an individual can save into their pension plan each tax year depending on their earnings. Under the old rules, an individual’s allowance would not reduce to lower than £4,000.
