Today’s Budget was a seismic event for pensions tax, seeing the most significant changes since the pension freedoms were announced in 2014.
The lifetime allowance (LTA) has been abolished completely, with big increases to the annual allowance (AA) and money purchase annual allowance (MPAA), as well as tweaks to the tapered annual allowance (TAA).
Lifetime allowance
The biggest change is that LTA abolition. Many workers over 50 left the labour market during the pandemic and the government wants to encourage people in this group to return to employment and extend their working lives. It believes abolishing the LTA entirely will help ensure individuals such as doctors are not disincentivised from remaining in the workforce.
The change reverses a decade of declining LTA, which discouraged higher earners from saving. However, tax-free cash will be limited for most people to the current maximum level of £268,275.
The change will hugely simplify pensions
This caveat means the abolition isn’t quite as positive as it first appears. While the harsh 55% LTA tax is being removed, benefits above the tax-free cash level will be subject to income tax.
But the ability to use pensions to cascade unlimited amounts of wealth tax efficiently to the next generation has been hugely enhanced, especially if the beneficiaries can pay lower levels of income tax.
The change will hugely simplify pensions, with many layers of complexity including checking benefits against the LTA removed entirely. However, the government says those with suitable protections will be able to receive higher amounts of tax-free cash, which does mean some complexities will continue to exist.
Annual allowance
The AA is increasing by 50% to £60,000 a year. In an additional boost for those in the public sector, open and closed public service pension schemes for a given workforce will be considered linked for the purposes of calculating the AA charge, with effect from 6 April 2023. This may allow members to offset any negative real growth in closed schemes against a larger increase in an open scheme.
Many higher paid workers will benefit from the boost to the annual allowance
These measures combined are estimated to cost over £1bn over the next five years.
This is a significant increase to the AA, which will particularly help those in defined benefit (DB) schemes with long service who get a promotion, as well as those whose earnings fluctuate.
As a policy clearly designed to encourage public sector employees to remain in work – primarily those in the National Health Service – it will be interesting to see how effective this change will be.
Come what may, many higher paid workers will benefit from this boost to the allowance.
Tapered annual allowance
There are also changes to the TAA, with the minimum TAA increasing from £4,000 to £10,000 from 6 April 2023. The adjusted income threshold for the TAA will also be increased from £240,000 to £260,000 from 6 April 2023. This helps those with the highest earnings save slightly more into their pension.
Money purchase annual allowance
The MPAA will increase to £10,000 a year from April 2023, significantly up from the current £4,000. This is a policy where we have lobbied for change and we’re pleased chancellor Jeremy Hunt has listened.
These are massive changes for the industry and many will be looking to advisers to help them
It will help many people who have had to access their pension due to the cost-of-living crisis, redundancy or the pandemic boost their pension saving, and fully benefit from their employer’s pension contribution without fear of triggering a tax charge.
While this is a small change to the rules, it can make a big difference to those affected and could even save the Treasury some money through increased employment, economic productivity and tax receipts.
Taken together, these are massive changes for the industry and mean many people will be looking to advisers to help them work out what they should be doing to maximise the benefits.
Andrew Tully is technical director at Canada Life
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