The pensions industry has grown used to low-key budgets in recent years with the legislative levers used to restrict the cost of pension tax reliefs rather than galvanising individuals to increase pension saving.
On 15 March 2023, however, all that changed when the Chancellor of the Exchequer, Jeremy Hunt, not only announced significant increases to the Annual Allowance (AA) and the Money Purchase Annual Allowance (MPAA) but also the abolition of the Lifetime Allowance (LTA) in its entirety.
The amount that can be taken in the form of a tax-free lump sum is, however, to be capped – with a stated intention that it will remain frozen at that level.
All these measures increase the scope for improving retirement outcomes and thus encourage those who may have ‘maxed out’ their tax-favoured pensions saving to continue in work or even to return to it. Most significantly, NHS workers have accelerated their retirement plans particularly in the wake of the COVID-19 pandemic and the Government hopes that these measures will stem or even reverse the tide.
The LTA for pension savings is being abolished. This will be a massive simplification.
The LTA will be abolished entirely from 6 April 2024, with the LTA charge being removed from 6 April 2023. This means no one will need to report or pay LTA charges from 6 April 2023.
Delaying full abolition of the LTA until 2024 would seem to be a practical approach as there are many elements within the pensions tax regime that cross-refer to the LTA or rely on LTA being available, for example Pension Commencement Lump Sum (PCLS) and lump sum death benefits. At some point in the foreseeable future we can expect an HMRC consultation (probably on legislative change rather than policy) on how the legislative regime will be changed to cope without the concept of an LTA.
The PCLS will be capped at £268,275 (25% x £1,073,100), other than where members have certain protections. Much of the current process around retirements and the percentage of LTA available will need to continue (at least until 2024) in order to determine the PCLS. Individuals with a protected LTA will NOT need to comply with the conditions for maintaining protection (such as no accrual in the case of fixed protections) as a pre-requisite for maintaining entitlement to a PCLS based on the higher (protected LTA). They must, however, have applied for protection before 15 March 2023.
Benefits that are currently chargeable to tax at 55% – such as lump sum death benefits above the LTA – will be taxable at the recipient’s marginal rate of tax from 6 April 2023.
While abolition of the LTA is a huge change and appears to open the door to unlimited pension savings, the AA will restrict the extent to which pension savings can be made and those most able to do so are likely to have their AA restricted by the AA taper.
Sponsors who have embedded the LTA into the design of their schemes, such as capping benefit accrual, may need to act ahead of the abolition of the LTA to ensure that the scheme continues to operate as intended and that they do not see a large increase in liabilities through benefits becoming uncapped.
In addition, the standard AA for pension savings will increase by 50% from £40,000 to £60,000 from 6 April 2023. This will apply to all pension provision, whether defined contribution (DC) or defined benefit (DB) and will allow DB members to increase their pension entitlements over and above inflation by up to £3,750 pa in retirement, as opposed to the £2,500 pa that is currently available with a £40,000 AA.
The increase will reduce the likelihood of individuals facing an actual AA charge, whether they are actively making new savings or where they lose the deferred member carve out from the AA, for example following a pension increase exchange or GMP conversion exercise.
The AA taper affects the highest earners only. Currently, where a person has threshold income (broadly, all taxable income) of at least £200,000 and adjusted income (again broadly, threshold income plus employer and employee pension contribution) of at least £240,000, the standard AA is reduced by £0.50 for each £1 of excess over adjusted income. There is an income floor that is currently aligned with the MPAA level ie irrespective of income, a contribution up to £4,000 can be made.
As the threshold income limit is defined as the adjusted income limit less the standard AA, with the standard AA increasing to £60,000, the adjusted income limit has been increased to £260,000 to keep the threshold limit unchanged.
In addition, the minimum AA has been increased in line with the change to the money purchase AA (see below) to £10,000.
Taken together, this means that the tapered AA will reduce to £10,000 once adjusted income is at a level of £360,000. This compares with the current position where the £4,000 taper floor is reached once adjusted income reaches £312,000.
The MPAA was introduced to mitigate the risk that individuals at or above the normal minimum pension age might access their money purchase (or DC) savings and re-invest this into pension and thus obtain further tax relief. Currently, once someone accesses their money purchase savings – other than just by taking a pension commencement lump sum – they are then subject to a special AA of just £4,000. Again, to encourage those who may have decided to leave the workplace – or significantly cut back their hours – the MPAA is to increase to £10,000.
A range of scheme designs have been put in place to limit the benefits that individuals accrue to prevent tax charges arising, such as capping DC contributions to £4,000 per year. While the changes to the AA don’t appear to cause any immediate unintended consequences, we expect that many operating such schemes will want to look again at the structures to ensure they are not now overly constraining the build up of pension benefits.
If the changes in tax allowances might be thought of as carrots to remain in work, the Government retains the stick option – of increasing the age(s) at which pension benefits can be accessed. The Budget was silent on these aspects, but we’re likely to see more on this in the future.
