Radical changes to pensions unveiled in the Budget mean that the total amount that people can build up in pensions will no longer be restricted from the 2023/24 tax year.
The amount you can pay into pensions each year and benefit from tax relief has also received a significant boost. These pension changes are aimed at encouraging the over-50s to remain in the workforce for longer, and reverse some of the cuts to allowances made in previous tax years.
Here, we explain which pension allowances are increasing, and how the changes may affect your retirement planning.
If you’re considering getting professional financial advice, Unbiased is offering Rest Less members a free pension review. It’s a chance to have a qualified independent financial advisor (IFA) take a look at your pension arrangements and give an unbiased assessment of your retirement savings.
The review is free and without obligation, but if the IFA feels you’d benefit from paid financial advice, they’ll go over how that works and the charges involved.
The Annual Allowance
The Annual Allowance is the amount you can contribute to your pension each tax year and receive tax relief on. Read more in our article How pension tax relief works.
The Chancellor announced that the Annual Allowance will rise to £60,000 in the 2023/24 tax year, up from the current £40,000 limit, or 100% of your earnings, whichever is lower. This includes all the money you pay into your private pension(s) as well as any payments into a workplace scheme, including employer contributions. However, the Annual Allowance stood at £255,000 in 2010/11, so it has still fallen considerably over the years despite the latest hike.
If you’re a particularly high earner, you may also get a lower Annual Allowance. For every £2 of income you receive over £240,000 – rising to £260,000 in 2023/24 – you’ll lose £1 of your annual allowance, down to a minimum of £4,000 (£10,000 in the 2023/24 tax year).
If you have a defined benefit or final salary pension, the Annual Allowance relates to the total amount of benefits you can build up in your scheme each year for tax relief purposes.
How could the rise in the Annual Allowance affect you?
The increase in the Annual Allowance means you can pay more into your pension without incurring what’s known as an Annual Allowance charge. HMRC has a useful Annual Allowance calculator to help you work out whether you have to pay tax on your pension savings.
The Annual Allowance charge isn’t a set rate – the amount you’ll pay will depend on which income tax bracket you’d fall into if your excess pension savings are added to any other taxable income you get. That means the charge for exceeding the allowance could be 20%, 40% or 45% of any pension savings you made above the Annual Allowance, depending on your circumstances.
Increasing the Annual Allowance could particularly benefit you if you have a big sum that you want to invest in a particular year. That’s because you can use so-called ‘carry forward’ to make use of any unused Annual Allowance from the last three years as long as you were enrolled in a pension scheme during that time. Read more in our article Pension carry forward explained.
Rob Morgan, chief investment analyst at Charles Stanley, said: “Raising the pension annual allowance to £60,000 could help many people build up their retirement nest eggs, especially if they are playing catch up owing to missing contributions in earlier years due to affordability or gaps in employment. For those whose earnings vary greatly from year to year it offers more scope to up-size contributions and better plan for retirement.”
The Money Purchase Annual Allowance
Once you’ve started withdrawing money from your defined contribution pension using flexible drawdown, your Annual Allowance falls from £40,000 to £4,000 in the current 2022/23 tax year. At this point it becomes known as your Money Purchase Annual Allowance (MPAA) and it’s the amount of pension contributions you will still receive tax relief on while accessing your pension.
However, the amount you can pay into your pension under the MPAA will rise to £10,000 in the 2023/24 tax year. This is the level it was originally at when the allowance was introduced in 2015. The MPAA was originally aimed at preventing people from taking money out of their pension, and then paying the same money back into their pension to benefit from tax relief.
However, you can take the 25% tax-free cash lump sum out of your pension without affecting your full Annual Allowance, provided you don’t withdraw further amounts as income. If you have a pension pot worth £10,000 or less you can withdraw this money without triggering the MPAA (but you must withdraw the entire fund). Read more in our articles What is the Money Purchase Annual Allowance? and Cashing in small pensions: what you need to know.
How could the rise in the Money Purchase Annual Allowance affect you?
The increase in the MPAA may also help those also those who plan to access their pension early on – perhaps because their income has fallen, and they need to dip into their retirement savings to cover rising living costs. This can limit their ability to save into their pension pot once their income recovers. Find out more about the implications of taking money out of your pension in our article Should I use my pension to boost my income?
It also gives over-50s more flexibility to continue working while also withdrawing money from their pension. Alice Guy, head of personal finance at interactive investor, said: “Raising the money purchase allowance from its current level of £4,000 to £10,000 allows workers who have retired and withdrawn taxable income from their pension pot more flexibility if they return to the workplace. The current paltry cap means they could miss out on employers’ contributions and find it much harder to save enough for retirement.”
The Lifetime Allowance
Chancellor Jeremy Hunt announced in the Budget that the LTA will be abolished in the 2023/24 tax year. The Lifetime Allowance is the maximum you can save in your pensions over your lifetime, without having to pay any extra tax charges when you take money out of them. In the 2022/23 tax year the Lifetime Allowance is £1,073,100. Read more in our article What is the pension Lifetime Allowance?
The Chancellor said he’d chosen to raise the allowance because higher paid professionals, such as NHS consultants, are choosing to retire rather than face tax charges for breaching the limit. However, the maximum pension tax-free cash lump sum that you can take has been capped at £268,275, or 25% of the current Lifetime Allowance. This means that even though it’s now possible to build a larger pot without incurring a tax charge, your tax-free cash lump sum won’t increase with it.
When the Lifetime Allowance was introduced in 2006 it was £1.5m, and gradually increased to reach £1.8m in the 2010/2011 tax year. It stood at £1,073,100 in 2020/21, and has since remained frozen.
How could the abolishment of the Lifetime Allowance affect you?
If you’ve saved considerable amounts into a pension over the course of several decades, or your pension investments have risen in value significantly, you may have ended up with retirement savings in excess of the current Lifetime Allowance, and could have faced a hefty tax charge. This is more likely to be the case if you’re fortunate enough to belong to a final salary (or defined benefit) pension scheme. With this type of pension, you’ll receive a guaranteed income at retirement, which is usually based on how many years you’ve belonged to the scheme and a proportion of your final year’s pay.
The abolishment of the Lifetime Allowance may prompt you to reconsider your retirement plans if you were concerned about breaching the limit. Rob Morgan, chief investment analyst at Charles Stanley, said: “This could mean some people that are close to, or over, the previous threshold could be encouraged back into work, or to continue for longer, as they could accrue further pension provision without being penalised when they take benefits. It is especially relevant for certain NHS professionals where the limit was an obstacle to a much-needed return to the workplace, but it applies to anyone that has built up significant pension provision and worries about overstepping the limit.”
For example, let’s take a retiree approaching age 75 who crystalised their £1m pension in the 2016-17 tax year, who took £250,000 tax-free cash and put the rest in drawdown. If they hadn’t made any further withdrawals, any amount above the LTA would face a 25% tax charge, with income tax on top to pay. If their pension had risen in value to around £1.4m, that would amount to a 25% charge of around £100,000 at the time, according to AJ Bell. They would no longer have to pay this hefty charge.
The removal of the Lifetime Allowance also provides pension savers with additional shelter from Inheritance Tax (IHT) because money held in a pension is typically exempt from IHT. The abolishment of the allowance means that pensions may increasingly be used as a tax-efficient way for the well-off to pass wealth onto the next generation.
Learn more about how the various pension allowances work in our article Understanding your pension allowances.
Where to get help
If you’re worried about breaching pension allowances, or concerned about how to manage these, you might want to get advice from a qualified financial advisor. It can be a complex area however, where it will almost certainly pay to get tailored professional advice for your personal circumstances in order to avoid falling foul of the rules and facing tax charges.
If you’re 50 or over and have a defined contribution pension, you can get free guidance on the options available to you from the Government’s Pension Wise service.
If you’re considering getting professional financial advice, Unbiased is offering Rest Less members a free pension review. It’s a chance to have a qualified independent financial advisor (IFA) take a look at your pension arrangements and give an unbiased assessment of your retirement savings.
The review is free and without obligation, but if the IFA feels you’d benefit from paid financial advice, they’ll go over how that works and the charges involved.
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