Budget 2023: Goodbye Lifetime Allowance

The UK Budget announced by Chancellor Jeremy Hunt in March 2023 has brought some significant changes to pension savings. One of the most notable changes is the abolition of the Pensions Lifetime Allowance (LTA), which has been a part of pension rules since 2006. In this blog post, we will discuss the abolition of LTA and other changes related to pension contribution allowances.

Pensions Lifetime Allowance

Rumours circulating before the Budget suggested that the Pensions Lifetime Allowance (LTA) would be raised to £1.5 million or even to its peak of £1.8 million in 2011/12. However, the most surprising announcement was the proposal to entirely abolish the LTA.

The LTA, which was introduced in 2006, has undergone multiple changes and is currently set at £1,073,100. It sets a limit on the amount that an individual can have in their pension pot, exceeding which they must pay additional tax when withdrawing it or reaching the age of 75. This cap encompasses both the individual's contributions and any returns that boost their pension pot. Currently, the penalty rates are 55% for lump sum withdrawals and 25% for excess income in addition to any income tax.

Hunt's changes will eliminate these LTA tax charges from 6 April onwards. Although the full abolition of the LTA still requires parliamentary approval, it will exist without any tax charge. The government aims to abolish it entirely by 6 April 2024. The impact on pension savers will be swift, as there will be no LTA charge for the 2023/24 tax year, regardless of the size of their pension.

Individuals can usually withdraw up to 25% of their pension benefits up to the LTA as a tax-free lump sum. The removal of the LTA will not affect this limit on tax-free lump-sum withdrawals. As of the 2023/24 tax year, the maximum Pension Commencement Lump Sum (PCLS) will remain at £268,275 (i.e., 25% of the LTA) and will be frozen thereafter, except for individuals who have a higher lifetime allowance or pension commencement lump sum protection.

The government's original intention was to prevent senior NHS practitioners from ceasing to contribute to their pensions due to pension tax charges, which may lead to early retirement or leaving the NHS. However, the decision to remove the LTA will benefit people across various industries, and the government hopes it will encourage experienced high earners to remain in the workforce for longer. If you have any doubts regarding your transitional protection arrangements, please consult your financial planner.

Pension Contribution Allowances

The annual allowance for tax-relievable pension contributions has been significantly reduced since it peaked in the 2010/11 tax year. However, for the first time in 13 years, it is now increasing from £40,000 to £60,000, a 50% increase. This increase will be beneficial for individuals with higher incomes who will be able to save more money into their pensions. The tax relief rules will remain the same, providing an incentive for people around higher and additional rate thresholds to save more into pensions and optimize their tax position through pension contributions.

The annual allowance is tapered for very high earners, but the point at which it starts to taper has increased to an 'adjusted income' of £260,000. This means higher earners will be able to take advantage of an increased annual allowance, and those where tapering applies can still pay more into pensions than currently possible, regardless of their income. The minimum annual allowance has returned to its original level of £10,000, which was reduced to £4,000 from the 2020/21 tax year onwards.

Another restriction for pension savers has been the Money Purchase Annual Allowance since the pension freedoms were introduced. It limits the amount of tax-relievable contributions that can be made to pensions for those who have flexibly accessed their pension pots, primarily through drawdown. Initially set at £10,000, it was reduced to £4,000 from the 2017/18 tax year. After lobbying from various pension providers, it has increased to £10,000 per year.

With the abolition of the LTA and the increase in the annual allowance for contributions, pension saving will become more attractive than it has been in recent times and re-establish the pension as the primary savings vehicle for retirement funding. Many with larger pension pots may have reduced or stopped contributing to pensions to avoid breaching the LTA, but these changes will encourage people to save more for retirement.

FAQs

Q. What is the current Pensions Lifetime Allowance (LTA) limit, and what is changing?

A. The current Pensions Lifetime Allowance limit is £1,073,100, and it will be abolished entirely from 6 April 2023, pending parliamentary approval.

Q. How will the removal of the LTA impact my pension benefits?

A. The removal of the LTA tax charges means that there will be no limit on the amount that an individual can have in their pension pot, and they will not have to pay any additional tax when withdrawing their pension or reaching the age of 75.

Q. What is the annual allowance for tax-relievable pension contributions, and how is it changing?

A. The annual allowance for tax-relievable pension contributions is increasing from £40,000 to £60,000 from 6 April 2023, providing an opportunity for individuals with higher incomes to save more money into their pensions. The point at which the allowance starts to taper for very high earners has also increased to an 'adjusted income' of £260,000.

Q. What is the Money Purchase Annual Allowance (MPAA), and how is it changing?

A. The Money Purchase Annual Allowance limits the amount of tax-relievable contributions that can be made to pensions for those who have flexibly accessed their pension pots, primarily through drawdown. The MPAA has increased from £4,000 to £10,000 per year, providing greater flexibility and encouraging those who have accessed their pension pots to continue saving for their retirement.

Q. Will these changes affect my Pension Commencement Lump Sum (PCLS) limit?

A. No, the removal of the LTA will not affect the limit on tax-free lump-sum withdrawals. As of the 2023/24 tax year, the maximum Pension Commencement Lump Sum (PCLS) will remain at £268,275 (i.e., 25% of the LTA) and will be frozen thereafter, except for individuals who have a higher lifetime allowance or pension commencement lump sum protection.

Conclusion

The proposed changes to the pensions lifetime allowance and annual allowance for tax-relievable contributions are significant and will have a profound impact on retirement savings. The removal of the LTA is a welcome change that will provide pension savers with greater flexibility and the ability to save more for their retirement without worrying about exceeding the lifetime allowance and facing punitive tax charges. The increase in the annual allowance is also positive news, as it will allow higher earners to save more money into their pensions and optimize their tax position.

The government's decision to remove the LTA and increase the annual allowance is part of a broader strategy to incentivise retirement savings and encourage people to remain in the workforce for longer. These changes are expected to benefit not only NHS practitioners but also individuals across various industries who have been impacted by the lifetime allowance tax charges. Overall, these changes are positive news for pension savers, and individuals should consult with their financial planner to understand how these changes will affect their retirement plans and any transitional protection arrangements they may have in place.

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