Pension tax changes: how to take advantage

TaxTalk - August 2023

read timeRead time: 17 mins

This year’s Spring Budget brought in a raft of changes to pension tax in favour of the taxpayer. We break down what you need to know.

As part of Jeremy Hunt’s efforts to “help people extend their working lives”, the recent Budget introduced some major changes to pensions tax. Although the measures primarily aimed to retain GPs and other doctors, they could also benefit anyone looking to grow their pension pot tax efficiently.

The headline changes are:

  1. The lifetime allowance will be abolished in two stages
  2. The annual allowance has been increased from £40,000 to £60,000
  3. The money purchase annual allowance is increased from £4,000 to £10,000.

Lifetime allowance (LTA) abolished

Before 6 April 2023, the LTA limited the amount of tax-relieved value that could be saved into a pension scheme. It did this by charging 55% Income Tax on excesses taken out as a lump sum, or 25% when used to pay pension benefits. The limit was £1,073,100, unless you had acquired certain protections.

From 6 April, the Income Tax charge no longer applies. Amounts that would previously have incurred the tax are instead treated as income taxed at marginal rates. But the LTA will still be relevant in determining the size of certain lump sums, and how to tax them.

For example, the pension commencement lump sum – a tax free sum available when an individual becomes entitled to pension benefits from their scheme – is normally limited to the lower of 25% of the pension fund, or 25% of the individual’s available LTA. So while there is a new upper cap of £268,275 (25% of the old LTA), those with LTA protections will have a higher cap.

Where an individual holds pension savings over the £1,073,100 limit and does not already have protection, they could now consider applying for ‘individual protection 2016’ – brought in when the LTA was reduced in 2016. It provides a personal LTA equal to the savings held at 5 April 2016, subject to a cap of £1,250,000.

But for tax return compliance please note that, despite the abolition of the LTA in 2023/24, the legislative changes will not be finalised until a future finance bill. This means that reporting on benefit crystallisation events remains in force and is still a required part of the tax return, if relevant.

An opportunity for Inheritance Tax (IHT) planning?

So far there have been no announced changes to the IHT treatment of pensions. Yet, in most cases pension funds not drawn before death will be passed to the beneficiary free of IHT. There can be a charge if the individual dies after age 75 (the beneficiary will draw down at their marginal rate) but this tends to be less expensive than IHT itself.

Those looking for ways to lower their exposure to IHT could now consider their pension as a possible vehicle, given these changes.

On the other hand, the Labour party has indicated it would want to reverse these changes. So there could be a risk to this strategy after the 2024 General Election. While previous changes to the LTA have come with protections to preserve what was available, we don’t know for sure if Labour would make such a provision.

Annual allowance increased

The annual allowance for pension inputs limits the amount of Income Tax relief on pension contributions per tax year. Before 6 April this limit was £40,000, with an additional taper of £1 for every £2 that an individual’s adjusted income exceeded £240,000, down to a minimum of £4,000. For example, an individual with an adjusted income of £250,000 – an excess of £10,000 over the adjusted income threshold – would lose £5,000 of annual allowance.

From 6 April, the new maximum limit is £60,000, and the adjusted income threshold has been raised to £260,000 with a minimum after tapering of £10,000. This will allow individuals to save even more into their pension tax efficiently – especially useful with no lifetime allowance charge looming.

Money purchase annual allowance increased

Similar to the annual allowance, the money purchase annual allowance limits Income Tax relief on contributions made specifically to those who have taken pension benefits from defined contribution or money purchase arrangements. The limit has been increased from £4,000 to £10,000.

Whether you are looking to build your pension with the enhanced annual allowances, or increase your existing pot thanks to the removal of the LTA charge, these changes provide scope for more fruitful pension tax planning. However, the planning opportunity needs to be balanced with the chance these changes are reversed by a Labour Government.

If you’d like more in-depth guidance and advice, please contact Sam Meir.