This alert gives a short summary of the announcements affecting pensions. No doubt further complexities will arise as the details of future legislation are considered. We will provide more in-depth analysis of the implications in further updates.
Abolition of lifetime allowance
The lifetime allowance (LTA) will be removed from 6 April 2023. This announcement goes way beyond the anticipated increase in the LTA to £1.8m (from its current level of just over £1m). Without the LTA, individuals who have yet to draw their pension benefits may contribute to their pensions for as long as they wish, without fear of market rises (or government intervention) resulting in a LTA charge. This is a very welcome aspect of the Chancellor’s strategy to encourage longer working lives.
Until the start of the new tax year on 6 April 2023, the LTA will continue to apply. Anyone retiring between now and 6 April and who is likely to face an LTA charge may wish to consider deferring retirement by a few weeks.
The current LTA increasingly catches not just the very well off but also those on middle incomes who have diligently saved for retirement throughout their working lives. Many working age individuals who stopped paying into their pension because of concerns of breaching the LTA may now decide to resume pension contributions. Employers who currently provide additional pay instead of pension contributions for staff at risk of exceeding the LTA will need to reconsider their approach to compensation for senior (or older) employees. Unregistered “top up” pension arrangements for senior staff subject to the LTA may also need revisiting.
Lifetime allowance: some background
The LTA was originally set at £1.5m in 2006, estimated at that time to be the amount needed to buy an annuity of around £70,000 per year – the maximum capped defined benefit (DB) pension which could be paid under the previous tax regime. An individual’s cumulative pensions valued above the LTA are subject to an LTA charge of 55% on lump sums and 25% on pension income (which is also subject to income tax).
Since 2006, falling annuity rates and decreases to the LTA have meant that a pension pot worth the LTA buys a pension of significantly less. The current levels of the LTA and AA distort decisions about savings for retirement for many and, for National Health Service (NHS) and other public sector staff, have led to doctors and other senior staff leaving public service earlier than they might otherwise have done.
Increase in annual allowance
The headline news on the annual allowance (AA) is that it will increase from £40,000 to £60,000 per year from 6 April 2023. The increase is helpful and will address some of the tax issues causing senior doctors and others to retire early from the public sector. This will be aided by technical changes to allow public sector workers to “link” their service in open and closed pension schemes.
However, those who have already dipped into their pension pots using the “pension flexibilities” are subject to a “money purchase annual allowance” (MPAA) of only £4,000 per year. This will increase to £10,000 per year from 6 April 2023 – a welcome increase but still a far cry from the £60,000 per year available to individuals who have not yet drawn any pension. Individuals who stopped contributing to their pension because of LTA concerns may have decided to access their pension early, in the knowledge that the restrictive MPAA would not have any impact on someone who had ceased pension contributions. Undoubtedly some individuals subject to the MPAA may now regret drawing their pension when they did, rather than relying on funds from other sources (such as ISAs or property).
Another group not benefitting to the full extent from the pension Budget announcements is individuals with an annual income (including the value of pension contributions) of £240,00 or more. Such individuals are subject to the “tapered annual allowance” – a gradual reduction in the AA, so that those with an adjusted income of £312,000 or more have an AA of only £4,000 per year. This will increase to £10,000 per year from 6 April 2023 and the threshold for the tapering to start will rise to £260,000. Again, this is a long way off the £60,000 per year allowed to those earning less than the tapering threshold.
Annual allowance: some background
The AA is the maximum an individual may contribute tax free to a UK tax-registered pension scheme in a tax year (with some carry forward provisions for unused AA from the previous three years). Any contributions in excess of the AA are subject to an AA tax charge at the individual’s marginal income tax rate. Any contributions paid by another person (such as an employer) for the member’s benefit are included when assessing liability to the AA charge.
Tax free cash (pension commencement lump sum)
The amount of tax free cash an individual can take on retirement will be limited to the current maximum of £268,275 and will be frozen going forward. For most people, tax free cash is already limited to 25% of the value of the pension being taken, so the £268,275 limit will only catch those with higher value pension pots.
Many higher earners have enhanced or fixed protection, giving them protection from the LTA charge and the ability to take a greater tax free lump sum than the normal rules allow. Currently, these protections are lost if the individual accrues further benefits or (in some circumstances) transfers to another scheme. These protections, plus any associated protected right to a higher tax free lump sum, will now continue even if after 6 April the individual accrues further pension benefits, joins a new pension arrangement or transfers to another scheme.
Promoting pension investments in UK long term projects
Continuing the government’s push to access pension funding for long term projects, the Chancellor has announced a new Long-term Investment for Technology and Science (LIFTS) initiative. The initiative is intended to facilitate the creation of new vehicles for investment in science and tech companies, tailored to meet the needs of UK defined contribution (DC) pension schemes. The government expects to deliver an “ambitious package of measures” by this autumn.
As part of this initiative, the government will accelerate the transfer of assets (£364 billion) held in the Local Government Pension Scheme (LGPS) into pools to support increased investment in innovative companies and other productive assets. Consultation is intended on whether LGPS funds should be required to consider investment opportunities in illiquid assets such as venture and growth capital.
It will be interesting to see how any new proposals reconcile the overriding duty on pension trustees to invest in the interests of their members with government’s desire to access pension scheme funding to help drive UK growth. Pension trustees should be very aware of the need for liquidity in their investments – particularly in DC arrangements where individuals may choose to switch their savings between investment funds or to a different pension provider. For defined benefit (DB) schemes, the market turmoil in autumn 2022 and the collateral calls experienced by pension schemes with liability driven investment (LDI) strategies underlined the importance of access to liquid assets.
Authored by the Pension Team.