In today’s Budget, the Chancellor of the Exchequer has announced dramatic pensions tax changes - increasing the annual allowance from £40,000 to £60,000, and scrapping the lifetime allowance entirely. The reforms are part of a bid to incentivise older earners to remain in the workplace. They promise to provide increased savings flexibility for many.
What are the existing limits?
Since April 2006 there have been limits on the amounts that can be taken from and paid into a registered pension scheme without incurring additional tax consequences. At present:
- an individual’s savings under all registered schemes must not exceed the lifetime allowance (LTA). This peaked at £1.8m for tax year 2011/12 but fell to £1m in April 2016, since when it has either been uprated by CPI, or not at all;
- the annual allowance (AA) limits the amount by which the value of a member’s rights under all registered schemes can increase in each tax year. There is also a tapered annual allowance, tapering down to £4,000, applying to those with income (including pension savings) in excess of £240,000;
- an additional restriction - the money purchase annual allowance (MPAA) - applies when a member has ‘flexibly accessed’ money purchase benefits (e.g. taken them as a taxable lump sum or put them into drawdown). In such cases, there is a smaller annual allowance, in relation to DC benefits only, of £4,000.
What was the problem?
In recent years there have been growing concerns that these limits disincentivise earners from staying in work, with some professions disproportionately affected. For example, NHS leaders have been vocal in saying the tax rules actively discourage senior doctors from working additional hours.
The MPAA - thought to affect some 25% of DC savers aged 55 or over - has also attracted growing criticism as running counter to broader Government policy, with an industry letter to the Treasury earlier this month describing it as an “older worker penalty”.
So what’s changed?
As widely trailed over recent days, the AA is to increase from £40,000 to £60,000 from 6 April. The income level for the tapered AA will also rise (from £240,000 to £260,000) and the MPAA and minimum tapered AA will return to their previous level of £10,000.
What was more of a surprise is that the LTA is not being increased, but abolished altogether. The Treasury promises that nobody will face an LTA charge from April 2023 and notes that as a result, existing LTA protections will effectively become redundant.
However, alongside abolition, the maximum pension commencement lump sum (PCLS) which a member can take at retirement will be restricted to 25% of the current LTA - a figure of £268,275 (save where the member already has a protected right to a higher PCLS). Consequential changes are being made so that where specified authorised payments are currently subject to a 55% tax charge above the LTA, they will now be taxed only at an individual’s marginal rate.
Contrary to some speculation, the Chancellor did not announce any further increases in normal minimum pension age (NMPA), which is to rise to age 57 in April 2028.
Other pensions aspects of the Budget
The Budget emphasises the Government’s desire to unlock DC pension fund investment into innovative UK firms, saying it will “work closely with industry and regulators to bring forward an ambitious package of measures by the autumn”. In the meantime, it will launch a Long-term Investment for Technology and Science (LIFTS) initiative, tailored to UK DC pension scheme needs, and accelerate the transfer of Local Government Pension Scheme assets into pools supporting investment in productive assets. In addition, the Government will consult on requiring LGPS funds to consider investment opportunities in illiquid assets.
The Budget materials also contain the expected measures:
- placing a duty on HMRC, from 6 April 2024, to make top-up payments to individuals who save into an occupational pension under net pay arrangements - if their total taxable income is below the personal allowance
- ensuring that a member of a collective DC scheme in wind-up can continue to receive authorised pension payments, and can transfer to another pension scheme and receive drawdown pension.
Conclusion and next steps
This is the first time for many years that the AA has received a significant increase - whilst the effective dismantling of the LTA represents a definitive break from the pensions tax regime in place since 2006. Many in the pensions industry will welcome the decision, given the complexities that arise from the various transitional LTA protections and the issues these can cause (for example, on transfers, or GMP conversion).
It will be important to consider the position of any members who might take action to crystallise benefits between now and 6 April, in order that they do not unnecessarily expose themselves to an LTA charge.
In any event, schemes should review and update their wider communication materials. Employers may also wish to revisit any arrangements they have in place, particularly for high earners, to mitigate the impact of the current restrictions. Employers that currently exclude members with LTA protections from being automatically enrolled (or re-enrolled) could now also reconsider their approach.
For further information, please speak to your usual CMS contact.