Chancellor springs a pensions surprise

What has changed?

Abolition of the lifetime allowance

The pensions LTA is essentially a cap on pension benefits and the LTA charge is an extra tax charge that applied if one’s pension funds exceeded the LTA. The LTA has been subjected to numerous changes from when it was introduced in April 2006 at a level of £1.5million, up to a peak of £1.8million and frozen at just over £1.07million since 6 April 2020. 

The LTA charge has now been abolished from 6 April 2023. This is arguably the most significant and far-reaching pension policy change since A Day, 6 April 2006. The LTA charge will no longer apply with effect from 6 April 2023 and the removal of the LTA completely is scheduled to follow from 6 April 2024 in the next Finance Bill.

Increase to the annual allowance

This annual limit on the level of pension contributions or accrual that each individual has available to them has been increased from £40,000 in each tax year to £60,000 with effect from 6 April 2023.

Tapered annual allowance

In recent tax years, the current annual allowance of £40,000 has been tapered to a minimum of £4,000 for ‘high earners’ once their income reached £312,000 and above. The tapering started at ‘adjusted income’ levels of £240,000 but this threshold is being increased to £260,000 from 6 April 2023. The minimum tapered annual allowance will also revert to its previous level of £10,000. High earners will not be limited to the maximum tapered annual allowance of £10,000 until they reach income levels of at least £360,000.

Increase to the Money Purchase Annual Allowance (MPAA)

The MPAA is currently set at £4,000 per tax year and limits contributions to defined contribution pension schemes for those who have already drawn income from their pensions. This will increase to its previous level of £10,000 from 6 April 2023.

Tax-free cash

Although the lifetime allowance has been abolished, there’s a sting in the tail within the detail with the confirmation that tax-free cash will not increase. The maximum total tax-free lump sum that you can draw from all pensions (where no form of protection is in place) has been capped at £268,275 from 6 April 2023. This represents 25% of the current lifetime allowance of £1,073,100.

Individuals who have previously registered for certain types of LTA protection (Fixed Protection and Enhanced Protection) will be able to maintain protection after 6 April 2023 and benefit from the greater protected tax-free cash entitlement provided to them. 

The Finance Bill has confirmed that it will be possible for individuals with LTA protection to accrue new pension benefits, join new arrangements or transfer to other pensions and still keep the protection, including the entitlement to protected tax-free cash. This is the case where the protection was applied for before 15 March 2023. There are many different types of LTA protection with some people having specific protection for their tax-free cash sum so it is important to review one’s situation on an individual basis when making decisions around accruing additional pension benefits.

Fixed Protection and Enhanced Protection

It is extremely important to note that protection will be lost if further pension benefits are accrued before 6 April 2023. As such, anyone with Fixed Protection or Enhanced Protection should be careful not to take any action that would invalidate protection in the 2022/23 tax year. 

Carry forward

The ability to use allowances that have not been fully utilised from the previous three tax years remains if you have been a member of a registered pension scheme for those years.

How will this affect you?

Many people will need to revisit their pension situation and overall financial planning to determine whether they should make changes in the light of these radical pension rule changes. 

If you are already affected by the tapered annual allowance, it will be possible to make larger contributions from 6 April 2023 even if you are tapered under the new rules. For many with income levels below £260,000, it will mean a 50% increase in one’s pension allowance, which can be very beneficial to prepare for retirement and claim tax relief. 

The new rules will also benefit those with income levels between £312,000 and £360,000 who will see their allowance increase from £4,000 to a minimum of £10,000 and potentially up to £34,000.

As pension contributions benefit from personal tax relief at one’s marginal rate, obtaining relief at up to 45% can be very tax efficient. There can also be planning considerations for those who are affected by the loss of the personal (tax free) allowance if income exceeds £100,000. In some cases, tax relief can be up to 60% if earnings are between £100,000 and £160,000.

In addition, for any individuals who were potentially restricted by the lifetime allowance, the new rules present an opportunity to add more to their pension and benefit from tax relief. However, it is important to consider one’s individual situation and the potential risk that pension rules could be changed again in the future. The decision to make contributions will of course depend on the level of pension funds already accrued as well as age, potential investment returns, other assets and general financial circumstances. Those who were previously restricted to the reduced Money Purchase Annual Allowance of £4,000 can now potentially pay more into their pensions to claim tax relief up to £10,000 which may be beneficial depending on one’s situation.

Individuals with LTA protection and who have earned income can consider whether to accrue additional pension benefits again from 6 April. This will be the first time since 2006 that this has been possible for those with Enhanced Protection. It is important to note that this does not necessarily mean that additional accrual will be the right option for everyone.

Clearly, each person will have different circumstances, pensions and future objectives so individual advice is important before making any decisions. However, there are likely to be planning opportunities for large number of individuals, particularly those who may have been very limited up to now.

A word of caution

The new rules, if enacted, could provide planning opportunities and benefits to many, but the full details are yet to be released. Clarification is expected in July 2023 as part of draft 2024/25 legislation for the next Finance Bill. 

Our concern is that pensions have for some time been an easy target for successive governments and there has been little consistency or long-term security. It is not inconceivable that a different government in the future (or even the current one!) could change these rules again. 

Winners and losers

Although the changes introduced are beneficial for many, as always there are those who will not benefit. Many pension scheme members may have recently paid lifetime allowance charges and it does seem unfair that they will not benefit from the abolition of the allowance. It will of course also bring some relief to those who have already had their pension benefits tested and used the lifetime allowance but would be due to have another test at age 75.

Plan ahead

As with any change, it is important to consider both the potential opportunities and how they may benefit you as well as other considerations. We would encourage individuals to review their specific position and consider different scenarios including potential legislative changes in the future to see how they can maximise their position in a tax-efficient manner and minimise any potential downsides for them. 

We will be looking at planning points in relation to pensions in more detail in future insights to come. Over the next few months, we are also planning to host sessions for clients who may be affected in different ways, such as for those with enhanced or different types of Fixed Protection. 

Our Financial Planning team are FCA regulated and can provide pensions advice on your specific situation.