In a shock announcement, Chancellor Jeremy Hunt has abolished the pension lifetime allowance.
This comes after previous Chancellors, including the sitting PM, had frozen the lifetime allowance at its current level of £1.073m until 2026.
The changes are not however as black & white as they appear; they are subtly nuanced with the introduction of a cap on tax free cash at the current rates, meaning excess benefits won’t suffer the 55%, but will still be subject to income tax at your marginal rate.
A Reminder
The lifetime allowance (LTA) is the maximum value of benefits that can be taken from a registered pension scheme without being subject to the lifetime allowance charge.
The LTA is currently £1,073,100 but it’s not always been this amount. It was introduced in 2006 at a level of £1.5m, gradually increased to £1.8m four years later, fell to £1.5m, £1.25m and £1m over a 5-year period known as The Osborne Pension Raid, then increased by inflation to its current level.
Any excess over the LTA can be taken as a lump sum and the charge is 55%.
Alternatively, the excess can be used to provide an income, by either a pension annuity or income drawdown. The charge is then 25% but of course any pension instalments or withdrawals made will be taxed at the individual’s marginal rate of income tax.
The Announcements
The Lifetime Allowance charge will be removed from April 2023 before the Allowance is abolished entirely from April 2024.
This is I presume, to give insurers time to sort out their systems. Great expense has gone into reporting LTA charges and this can’t be unwound in a day.
Next year, I suspect any crystallisations will still be measured against the LTA, you can still breach the LTA, you just won’t have to pay the LTA charge, only income tax on any excess.
I’d hold off doing anything in the short term as I would want to make sure the LTA charge is not paid by default, as some providers will have it set up to pay automatically. Speak with me before you pull any triggers.
I’d also want to make sure this legislation actually goes through as the Budget report later states, “the Government will remove the Lifetime Allowance charge, before completely abolishing it in a future Finance Bill”.
We may well have a future General Election and a different Government before a future Finance Bill.
Assuming it all does go through smoothly, this does not mean you should tear up any previous protections that are in place.
The maximum Pension Commencement Lump Sum (a.k.a Tax Free Cash) for those without protections will be retained at its current level of £268,275 and will be frozen thereafter.
In laymans terms, tax free cash remains at 25% of your pension fund up to the current LTA. This means that while you are no longer faced with the prospect of a 55% tax charge, you won’t be able to benefit from tax free cash on unlimited pension pots.
The headlines reported are larger than the savings.
This is not a 100% saving of the 55%.
Additional rate taxpayers will continue to pay 45%, a 19% saving.
Higher rate taxpayers will pay 40%, a 27% saving and basic rate taxpayers, (which should be most people in retirement), a 50% saving, since most basic rate taxpayers could reduce the 55% to 40% through careful planning in any event.
What About Contributions?
In addition to the changes to the LTA, the Government have raised the Annual Allowance for pension contributions from £40,000 to £60,000 and the minimum Tapered Annual Allowance from £4,000 to £10,000 from 6 April 2023.
If you have LTA protection, you have a decision to make. If you contribute, you invalidate your protection and will be restricted on tax free cash.
Most people who have protection but are yet to take benefits have it at £1.25m or £1.5m. That’s between £62,500 and £125,000 tax free cash you would be giving up.
Detailed analysis will need to take place to determine if its worth making any future payments.
While the LTA rule book has been ripped up, that doesn’t mean it’s a free for all as we still have to take account of the Tapered Annual Allowance.
Even though this is being increased from £240,000 to £260,000, the reality is those who can afford to contribute between £40,000 and £60,000 a year into pensions will likely be restricted to £10,000 in any event.
Comment
The rationale for these reforms is “to help ensure that high skilled individuals such as NHS clinicians are not disincentivised from remaining in the workforce.”
This is true. As well as the LTA issues, many members of generous final salary pension schemes found themselves with phantom tax charges due to the annual increases in their benefits.
While it may be a stretch for a money purchase member to afford the maximum £40,000 (let alone £60,000), these limits are well within the reach of final salary pension members where the annual allowance is based on a formula, not the actual amount contributed.
Of course it’s not just NHS clinicians who benefit from generous final salary pensions, its civil servants…and Members of Parliament.
That being said, I welcome any change that encourages saving for retirement. A cap, no matter how achievable, is sometimes enough to put off those at the start of their savings and for that alone, this abolishment is welcome.
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