The budget contained a number of alterations to the pension allowance regime, with the rabbit out of the hat moment being the effective removal of the Lifetime Allowance (LTA) from next month.
The following day featured headlines from Labour saying that they will reverse the removal of the LTA if they win the next general election. It is easy to say this, but to do so would be complex and may even require a round of LTA "protection" we last saw in 2016. Alternatively, a Labour government may simply look to maintain or reduce limits on the tax free lump sum you can take and the general treatment of death benefits.
It makes it very difficult to plan when pensions are used as a political football and there is no certainty about the regulatory environment in the short term, particularly given pensions are about planning over multiple decades into retirement.
In terms of the Budget announcements, the three main pension annual allowances are all to be increased from 6 April:
- The Annual Allowance (AA) is increasing from £40,000 to £60,000;
- The Money Purchase Annual Allowance (MPAA) is increasing from £4,000 to £10,000;
- The tapered annual allowance calculation is altering, with the taper only starting for Adjusted Incomes over £260,000 and the minimum resultant allowance being increased from £4,000 to £10,000.
All of these will allow larger pension contributions to be made whilst receiving full tax relief.
However, the dominant headline was about the removal of the LTA. So, with one eye on the next General Election, and with the caveat that little specific detail is yet available, what does the effective removal of the LTA from 6 April mean?
Whenever pension benefits are crystalised there will no longer be an LTA tax charge (though for 2023/24 there will still be an LTA test). From 2024/25 the process may be simplified, though it may be that some complexity remains given that there will be the necessity to monitor cumulative tax free lump sum payments.
The previous rules were that the tax free lump sum was 25% of the pension value, limited to at most 25% of an individual's LTA. For the standard LTA of £1,073,100 this meant a maximum lump sum of £268,275. Going forward, this maximum is now frozen, though those with a historically protected LTA (Enhanced, Primary, Fixed or Individual Protection) will retain their increased lump sum as 25% of their protected LTA. For example, for an individual with fixed protection 2012 and a protected LTA of £1.5 million, then their maximum lump sum will be £375,000. This will mean, therefore, that it will be necessary to continue to monitor and keep track of any protection in order to secure the increased lump sum access.
One specific point, only confirmed subsequently by HMRC, relates to those with Enhanced or Fixed Protection. Previously, retaining this protection necessitated making no further pension accrual. This restriction will be lifted from 6 April. This is a potentially significant change for those affected.
Previously the LTA tax charge when applied was 25% or 55% depending upon whether the net benefits were taken as income or a lump sum. This would apply when:
- Benefits above an individual's LTA were crystallised;
- A member reached 75 with uncrystallised benefits;
- On the death of the member pre age 75 and with uncrystallised benefits.
Going forward, no LTA tax charge will arise. For "lump sum" withdrawals (beyond the tax free lump sum limit), these will be taxed at marginal income tax rates.
Overall, as an example, for someone with a SIPP value of £2,000,000 then the removal of the LTA tax charge means that a future tax charge of around £230,000 will now not be applied.
The continued limit on the tax free lump sum is a slight mitigation on the impact of the LTA removal, but overall it is clear that the removal of this allowance and related tax charges is a significant tax benefit for those with pensions that are or will be above the previous limit.
Subsequent media discussion has focussed on the further enhancement to the treatment of death benefits for funds within the pension environment. Those with sufficient income and cash flow to freely utilise the annual allowances may now look to do so, even if their fund is over the previous LTA limit, receiving high marginal rate tax relief and in the knowledge/expectation that no tax will arise on death in respect of any funds remaining within the pension. This includes no Inheritance Tax. Though as noted above, this is an area that Labour may look to review post the next election should they be in government.
For these affected, some questions to consider:
- Should I defer any planned withdrawal which will incur an LTA tax charge until 6 April or later?
- If I have reduced or stopped pension contributions due to being near or over the LTA, should I resume/increase contributions?
- If I have reduced or stopped pension contributions in order to retain Enhanced/Fixed protection, should I resume/increase contributions?
- Do I want to take advantage of next year's increased Annual Allowance of £60,000?
- Do I want to take further advantage of the increased efficiency of pensions for passing funds down the generations?
- Should I review and potentially increase the risk level in my pension? (We have never been minded to do this, but some have previously recommended adopting a cautious investment strategy where the "growth" would have incurred an LTA charge. This strategy is no longer relevant.)
- Do I want to plan on the basis that the next government may unwind some of these changes?
The proclaimed motivation for these changes is to incentivise those who have retired early, or who were considering doing so in the near future, to remain in or return to work due to the improved pension tax treatment. This has been a specific issue for the NHS. However, it is easy to doubt the effectiveness of these changes in achieving this objective.
Spare a thought for those who turned 75 recently and incurred a forced LTA tax charge that would not arise from 6 April. And special commiserations to those who reach 75 between 15 March and 5 April 2023 and who may incur an LTA tax charge for the sake of a few days.
Overall though, the removal of the LTA is a significant positive for those who currently have significant pension funds, and those who may look to accrue such in the coming years. Many may well look to resume pension contributions having previously ceased doing so due to a combination of the LTA, the Annual Allowance, and the protections available.
Please get in touch if you would like to discuss your own personal circumstances.
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