At the time of writing there is limited detail available, but we will be watching the announcements in the next few weeks and will update clients as relevant details emerge. In the meantime, here is our initial take on the Budget tax measures as they affect our clients.
Abolition of the Lifetime Allowance (LTA)
The rules around pensions did indeed feature largely in the Budget, with the standout aspect being the abolition of the Lifetime Allowance. The Lifetime Allowance or LTA is the cap on the level of tax-relieved pension contributions that can be accumulated by any individual before a charge is applied to the fund when benefits over the cap are drawn and at certain other stages including reaching age 75. The LTA level has been successively reduced from a high of £1.8m and, in the 2022–23 tax year stands at £1,073,000. Last year it was frozen at this level until 2026.
The NHS’s well-publicised difficulty in retaining senior doctors has been largely put down to problems in managing the NHS pension scheme in the context of the LTA. As many of our clients will know, however, the LTA is not just an NHS issue and other people at a senior stage in their careers of any kind have experienced issues with it. In light of the country’s employment under-participation issues, it was clear that the LTA had become a barrier to continued work for the over 50s and something needed to be done about it.
The press speculated this week that the LTA would be restored to its original level of £1.8m. This would have been a significant leap from the present frozen £1.07m, but still way below the £2.5m+ level it would have got to if it had been increased each year with inflation. Instead, Jeremy Hunt announced that the LTA charge will be abolished from April 2023 and that the LTA itself will be removed in future legislation.
It’s not entirely clear how the timing of this policy will work. Taking the announcement at face value, it seems that no pension scheme with a pot exceeding the present £1.07m level will be subject to a charge after 5 April 2023. Given that one of the events giving rise to a charge is a person’s 75th birthday, that could be unfortunate for anyone celebrating their three-quarter century on or before 5 April 2023.
Many with substantial pension pots have a form of ‘protection’ fixing their LTA at a higher level than the current £1.07m. While these protections could simply become redundant, it seems they may still have relevance in capping the amount of tax-free cash that can be withdrawn from the fund. In the absence of a protection, the tax-free cash remains limited to 25% of the current LTA, i.e. £268,275. So, while the LTA may be history as a charging mechanism, it doesn’t mean that pensioners can take unlimited tax-free cash.
There is also the question of how this will fit in with other aspects of the tax system. Pension pots are currently free of inheritance tax. The tax applicable on death depends on a number of factors, but, at worst, a pot which has been subject to the LTA charge can be passed on to your heirs who may then extract funds from it with tax due at their own marginal rates. Lifting the LTA charge makes the pension pot even more attractive to those who seek an IHT shelter with the option of access to the funds if circumstances require.
Annual Allowance increased
Another aspect of the Budget pension changes is the raising of the Annual Allowance from £40,000 to £60,000. The Annual Allowance is the government’s other mechanism for controlling the cost of pension contributions, putting a cap on annual tax-relieved pension contributions that can be made by any individual. When Jeremy Hunt last addressed the Commons in the autumn he reduced the income tax additional rate threshold from £150,000 to £125,140. There is no suggestion in the Budget documents that this reduced threshold has been changed. Nevertheless, if a person can now make pension contributions of up to £60,000, the possibility emerges for those with earnings up to £185,140 to avoid the 45% additional rate tax by making pension contributions.
The Annual Allowance is ‘tapered’ for those earning over £240,000, reducing by £1 for every £2 excess income to £4,000. This earnings threshold is also to increase – to £260,000 – which will doubtless be welcome but may still cause the highest earners difficulties in making significant pension contributions. There was also a measure of relief for those who have already accessed their pension scheme – they too have a reduced £4,000 allowance for pension contributions, also known as the Money Purchase Annual Allowance or MPAA. That MPAA is now to be increased to £10,000.
From the employer’s angle, corporation tax is due to go up to 25% from 1 April 2023. The opportunity to make additional pension contributions may be a good route to reducing corporation tax charges, especially if the contributions are made as ‘salary sacrifice’, allowing savings on national insurance contributions too.
Ultimately, pensions remain the gold standard of tax-incentivised savings with income tax relief on the way into the fund, tax-free growth and a measure of tax relief (the 25% tax-free cash) on extraction. And IHT protection is really the cherry on the icing on the cake. The abolition of the LTA means that pensions are not to be penalised for growth, but, as you might expect, there are still measures in place to restrict the amounts you can put in with tax relief. The detail could change the landscape in the coming weeks, but, as we stand now, pension contributions for 2023–24 are looking better than they have for several years.
Tax laws are subject to change and taxation will vary depending on individual circumstances.