The Chancellor has delivered the UK Spring Budget 2023.
Over the past decade and more the pensions industry has grown used to legislative levers being used largely to restrict the cost of pension tax reliefs, adding ever-more complexity to an already complex system.
All that changed in this Spring Budget when, seeking to encourage greater economic activity amongst the over-50s (and specifically to alleviate concerns that the pensions tax regime is forcing senior clinicians within the NHS to reduce hours or retire early) the Chancellor of the Exchequer announced not only significant increases to the Annual Allowance and the Money Purchase Annual Allowance, but also the abolition of the Lifetime Allowance in its entirety.
Whether these changes would survive a change of government is a matter for conjecture. But the next general election is expected Autumn 2024 (and must take place by 24 Jan 2025) and, responding to the Chancellor’s budget speech, the leader of the Labour Party said that “the announcement today [on pensions allowances] is a huge giveaway to some of the very wealthiest. The only permanent tax cut in the Budget is for the richest 1%.”.
The Lifetime Allowance (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 disclosure and communication 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) in order to maintain entitlement to a PCLS based on the higher (protected LTA). This will remove one tax block to GMP conversion exercises. They must, however, have applied for protection before 15 March 2023. Inflation will erode the real value of a fixed maximum PCLS. For a person retiring in 30 years’ time, the amount available tax-free could be around half as valuable in real terms (ie adjusting for inflation) than it would have been had the existing LTA instead been uprated with CPI each year.
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 (and unlimited intergenerational wealth transfers unless the treatment of death benefits is adjusted), the annual allowance (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.
For sponsors who have embedded the LTA into the design of their schemes, such as capping benefit accrual, they 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.
Individuals who may have expected to be affected by the LTA are likely to welcome its abolition. However, those who have opted out of defined benefit schemes for LTA purposes may find themselves now unable to opt back in (at least to most private sector schemes). In addition, anyone who has recently paid an LTA charge may feel slightly aggrieved.
Schemes may wish to offer members due to crystallise benefits before 6 April 2023 (those who face an LTA charge, anyway) an opportunity to postpone crystallisation until after that date. While this may be challenging, it seems inevitable that members who face a charge (“unnecessarily”) will not appreciate this and many may complain. More generally, the administration changes associated with the LTA abolition will be very considerable.
The LTA created a need for, and helped fuel the rise in the use of, Excepted Group Life Policies (EGLPs). Fundamentally, this is because registered death in service benefits from an employer’s scheme are aggregated with all other registered lump sums, for example, the return of a pensions savings pot. An EGLP is not a registered scheme and sits outside of the pensions framework; it is not subject to the LTA. Currently, over 2 million people are insured in EGLPs. The abolition of the LTA raises the question as to whether EGLPs are still required. EGLPs are often seen as a more straightforward basis for group life cover, as there is not the need for HMRC reporting in the same way as with registered cover, but where operating with salary sacrifice they can have a complicated benefit in kind position.
The MPAA will increase to £10,000 from £4,000 with effect from 6 April 2023. This is the level it was set at originally when it was introduced alongside the defined contribution (DC) pension freedoms in 2015. The MPAA was introduced because the government wanted to prevent older individuals from effectively drawing 25% of their earnings tax free by contributing to a pension and then drawing it out straightaway while still allowing people who had drawn on their pensions to be able to make pension contributions. The change is part of a package to reduce barriers to individuals who have ceased work (and drawn on any DC pension savings, flexibly) from returning to employment and making further pension saving.
The MPAA was reduced to £4,000 from the 2017-18 tax year as the balance of risk shifted to preventing tax leakage. The government sought to prevent the MPAA from negatively impacting on the future development of automatic enrolment (AE) by allowing contributions to be made on qualifying earnings (QE). Currently, earnings between £6,240 and £50,270 must be pensioned under AE and an 8% contribution on these would deliver a contribution of £3,522.40. However, its calculation did not take into account that many larger employers meet their duties by pensioning basic salary from the first pound and this can exceed the current limit.
The level of the MPAA was already an issue, and would become even more of a sticking point in relation to a widely called for expansion of the automatic enrolment regime which proposed removing the lower limit. If this removal were to be implemented the minimum contribution under AE would exceed the current MPAA even on a QE basis (albeit marginally – £4,021.60). The Pensions (Extension of Automatic Enrolment) (No. 2) Bill, is currently passing through Parliament and it proposes allowing the government to reduce or eliminate the lower limit through regulations. Although not a Government Bill, a DWP press release says that it supports this, albeit that the intention is that the Bill “will not result in any immediate change”. Increasing the MPAA to £10,000 will therefore negate potential criticism that there would otherwise be a tax barrier to making earnings from the first pound become pensionable under AE.
While there are no new anti-avoidance provisions designed to counter individuals reducing their tax by diverting salary through pension, the government has announced plans to introduce a new criminal offence for promoters of tax avoidance who fail to comply with a legal notice to from HMRC to stop promoting a tax avoidance scheme.
The standard AA for pension savings will increase by 50% 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 decrease the likelihood of individuals facing an actual AA charge, whether they are actively making new savings, are choosing options at retirement which increase their starting pension or lose the deferred member carve out from the AA. Examples would be following a pension increase exchange, where they take-up a bridging pension option or a GMP conversion exercise. This may make such options more attractive.
The Budget papers confirm that it will still be possible to carry forward unused AA from the previous three tax years; they are silent on how carry forward will be determined so we assume that will be unchanged. This would mean that carry forward will continue to be determined by reference to the actual AA in a particular tax year ie for the tax years prior to 2023-24 the amount available for carry forward will be the difference between £40,000 (or tapered AA if lower) and the value of pension savings made in that tax year.
Although in the longer term, the increases in the AA should lead to a reduction in administration, in the short-term, systems and communications will need to be updated to reflect the new limits.
The AA stood at £255,000 when it last operated as originally intended, as “a light touch compliance regime”. It reduced to £50,000 with effect from the 2011-12 tax year to “raise revenues from restricting pensions tax relief” and there was a further reduction, to £40,000 from the 2014-15 tax year, to “protect the public finances from [pensions tax relief] growing cost”.
So why the turnaround? HM Treasury explains that “these reforms will help ensure that high skilled individuals such as NHS clinicians are not disincentivised from remaining in the workforce.”.
£60,000 is the highest level of standard AA since its nature changed from a light touch compliance measure to an Exchequer cost control. As noted, the AA reduced to £50,000 from 2011-12 and, had it been indexed to CPI inflation throughout the period since then, its level would have been around £68,930 in April 2023. However, when the government reduced the AA to £50,000, it made clear (within its response to the consultation on reducing the allowance levels, that there was no intention to index the £50,000 AA until at least 2016-17 (subsequent to which, it reduced the AA to £40,000 anyway, as already noted).
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 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.
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, ie at the current MPAA/tapered AA limit. Such policies will need to be reviewed immediately; the primary concern will be short term planning issues for those who have already opted into sections with capped contributions for the 2023-24 tax year and how employers deal with this.
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 both private and State pension benefits can be accessed.
In his Autumn Statement, the Chancellor stated that “The Government’s review of the State Pension age will be published in early 2023” and as recently as January, the DWP confirmed that the Government would conclude the second Government review of the State Pension age in early 2023. There had therefore been speculation that the Budget would be accompanied by publication of the Government’s report on increases to the State Pensions age. There had also been rumours that the normal minimum pension age might be increased beyond the increase to age 57 in 2028. In the event the Budget was silent on these measures, but we’re likely to see more on this in the future with the SPA review due by 7 May. In addition, we still await details of the transitional arrangements for increasing the NMPA to 57.
This Budget like many of its predecessors reiterated Government commitment to using DC funds to invest in firms and sectors that it seeks to champion, this year it's innovative firms. It cited the important steps to address barriers and accelerate progress that it has already taken and promised to “work closely with industry and regulators to bring forward an ambitious package of measures by the autumn”.
This Budget has an initial package which it believes will spur the creation of new vehicles for investment into science and tech companies. It hopes to tailor this investment to the needs of UK DC pension schemes, through a new Long-term Investment for Technology and Science (LIFTS) initiative. It will be interesting to see how this evolves and whether it can prove attractive tor trustees of large Master Trusts.
As had been widely predicted, the Chancellor announced that the Energy Price Guarantee would remain at its current level for a further three months, by which time prices are expected to have come down; the rise previously scheduled for April would have seen a typical dual fuel bill rise from £2,500 per annum to £3,000. For schemes whose reference month for pension increases is April, May or June, this ought to reduce 12-month CPI inflation by a little over one percentage point, with a slightly bigger effect on RPI. However, this may only affect uncapped increases; Bank of England forecasts indicate that a reduction on this scale is unlikely to be enough to bring inflation below 5% in this period.
Following a consultation in summer 2022, HMRC confirms that technical changes will be included in Finance Bill 2022-23 to enable CDC schemes to pay periodic income during the winding up period and then designate those funds into drawdown. In addition, under DWP legislation, a CDC scheme on winding up, effectively, creates individual “pots” that are then discharged to each beneficiary. Amendments will be made to ensure that this “quantification process” does not have unintended tax consequences for dependants. Royal Mail is expected to launch the first CDC scheme during 2023 and the Government is currently consulting on extending the opportunities for CDC schemes to multi-employer and, potentially, decumulation only schemes.
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