Budget: changes to pension savings limits
From 6 April 2023 the pension savings annual allowance will increase and the lifetime allowance charge will be removed.
Increases to tax free pension saving
To strengthen the labour market by removing disincentives to remain in work for individuals who might otherwise consider retirement, significant changes will be made to the limits on tax relieved pension savings in registered pension schemes. The standard annual allowance will increase from £40,000 to £60,000 and the lifetime allowance charge will be removed. The minimum tapered annual allowance will increase from £4,000 to £10,000, as will the money purchase annual allowance. Whilst these changes will be welcomed by affected individuals, it will be necessary to consider the detail of how these reforms might affect those with significant pension savings and relevant pension protections.
The current position
Pension savings under a registered defined contribution pension scheme are, in summary, treated as follows:
- Employer’s contributions are exempt from both income tax and national insurance contributions; and
- Employee’s contributions are eligible for income tax relief provided they do not exceed the member’s UK taxable remuneration.
However, to the extent that the total pension contributions exceed the member’s available annual allowance in any tax year, these are subject to an annual allowance charge at the employee’s marginal rate of income tax.
The current standard annual allowance is £40,000. For individuals who have both ‘threshold income’ above £200,000 and ‘adjusted income’ above £240,000, the standard annual allowance tapers down by £1 for each £2 of adjusted income above £240,000.
This means that the minimum tapered annual allowance for those with adjusted annual income of £312,000 or more will be £4,000 (though individuals can potentially carry-forward any unused annual allowance from the last three tax years).
When the member takes distributions from the scheme after age 55:
- They can take up to 25 percent of the funds within their available lifetime allowance free of tax (the standard lifetime allowance is currently £1,073,100, which caps the tax-free lump sum at £268,275, though some individuals have a protected right to take a higher pension commencement lump sum);
- The remaining funds within the lifetime allowance are subject to income tax; and
- Any remaining funds in excess of the lifetime allowance are subject either to the lifetime allowance charge at 55 percent if taken as a lump sum, or to the lifetime allowance charge at 25 percent, plus income tax at the member’s marginal rate, if taken as a pension.
A money purchase annual allowance of £4,000 also applies to limit the amount individuals can contribute to defined contribution pension schemes after having flexibly accessed a pension.
The tax treatment of defined benefit registered pension schemes is essentially similar, but there are important differences. For example, the annual benefit accrual (calculated according to a prescribed statutory formula) – rather than contributions made – is tested against the member’s available annual allowance.
From 6 April 2023, the standard annual allowance will increase from £40,000 to £60,000. Individuals will still be able to carry forward any unutilised annual allowance from the previous three tax years as at present.
The ‘adjusted income’ threshold for annual allowance tapering will increase from £240,000 to £260,000 and the minimum tapered annual allowance will increase from £4,000 to £10,000 (meaning that individuals with annual adjusted income of £360,000 or more will have an annual allowance of £10,000).
The money purchase annual allowance will also increase to £10,000, serving to encourage those drawing a pension to continue working.
Also from 6 April 2023, the lifetime allowance charge will be removed, with the lifetime allowance itself formally abolished at a future date.
The maximum tax-free pension commencement lump sum will be capped at £268,275 (i.e., a restriction set at 25 percent of the current lifetime allowance) for individuals without relevant pension protections and maintained at that level.
What should pension scheme member and employers consider?
The proposed reforms give rise to a number of points to consider, which include:
- For those with relevant lifetime allowance protections, it will be critical to confirm how these reforms will affect their tax-free pension commencement lump sum once the detailed legislation is available (e.g. those with certain types of protections could lose these if they restart pension contributions and this may significantly impact the enhanced tax free lump sum they are currently entitled to by reducing it to the frozen £268,725 instead of 25 percent of their previously protected lifetime allowance);
- Similarly, those with UK tax relieved savings in international pension plans where the annual and lifetime allowances apply (e.g., inbounds currently in the UK or those with legacy pension plans based overseas from periods of UK working) who are considering pension consolidation or are approaching retirement should consider taking detailed personal advice in order to confirm their specific UK tax positions;
- Abolition of the lifetime allowance might make it more attractive to transfer foreign pension plan funds to UK schemes;
- As the annual allowance will increase, and unutilised annual allowance can still be carried forward – and as a lifetime allowance charge will no longer potentially be incurred on reaching age 75 (or on dying before reaching age 75) – some individuals might want to consider whether enhanced pension contributions might have a role in inheritance tax planning (assuming they would be able to claim associated income tax relief, and registered pension savings remain outside the estate for inheritance tax purposes) – although bearing in mind that in many cases the recipients of post-death distributions from the pension scheme will be subject to income tax at their marginal rate;
- As registered pension scheme savings will no longer be subject to lifetime allowance ‘testing’ at age 75 (with the lifetime allowance charge being imposed on any ‘excess’ monies), this may encourage many members to delay taking benefits (and, in some cases, not even taking lifetime distributions at all);
- There could also be further complications in relation to defined benefit arrangements (as e.g. the legislation currently allows ‘lifetime allowance excess’ benefits to be taken in lump sum form before reaching age 75);
- Employers might consider how they could communicate these changes to employees so that they understand the role their pension now plays in their total reward package, and what changes might be made to the employee value proposition (e.g. offering affected employees the opportunity to increase pension contributions flexibly from April 2023 in order to benefit from the increased annual allowance);
- Employers who operate a cash alternative to pensions for higher earners who are subject to the tapered annual allowance will need to revisit the thresholds and amounts in the light of the changes announced;
- For pension providers there will be administration tasks in updating and reviewing customer documentation and internal systems and processes, with changes coming in soon on 6 April 2023. Further ahead, the detail in the Finance Bill will be important for pension schemes; and
- What are the potential implications of any future changes to the proposed reforms? As has become clear over recent years, the taxation of pensions is subject to change, which presents a challenge for those seeking to plan ahead for retirement over the longer term. Any potential steps in response to the reforms announced at the Spring Budget should be considered in light of the possibility of further future change (e.g. a future Government potentially re-introducing a lifetime allowance).
Please contact this article’s authors, or your usual KPMG in the UK contact, to talk through how we could assist you to understand the implications of these announcements for your employee pension arrangements.