Spring Budget 2023: Pensions tax changes

£60,000

Pensions annual allowance increased from £40,000 to £60,000

Lifetime allowance

The lifetime allowance (currently £1,073,100) will be abolished.

The Chancellor announced major changes to pensions allowances with the aim of encouraging the over 50s to remain in, or return to, work. This is particularly pertinent to high earning senior clinicians in the NHS. In recent years, many high-earning NHS medics have retired early or reduced their hours in order (at least in part) to avoid incurring pensions tax charges in respect of their defined benefit pension accrual. The changes are all, however, applicable generally.

The announced changes are as follows:

The lifetime allowance (currently £1,073,100) will be abolished.
The annual allowance will be raised from £40,000 to £60,000.
The tapered annual allowance will be raised from £4,000 to £10,000, with the 'adjusted income' threshold increased from £240,000 to £260,000.
The money purchase annual allowance will be raised from £4,000 to £10,000.
The maximum tax-free pension commencement lump sum (for those without protections for higher amounts), currently set at 25% of the lifetime allowance, will be retained and frozen at that level, which is £268,275.

These changes take effect for the 2023/24 tax year and thereafter. Technically, it is only the lifetime allowance tax charge that will be abolished from April 2023, with the full lifetime allowance legislation to be repealed from April 2024.

Labour have said that they would reinstate the lifetime allowance (whilst making specific arrangements for senior NHS clinicians) but have not said anything about existing or new protections.

Background

Lifetime allowance: This is the maximum amount of pension savings an individual may have in total in all of their registered pension schemes at the point(s) of crystallisation before a 55% tax charge applies (or 25%, if the excess is taken as a pension, in addition to the income tax). For defined contribution (DC) schemes, the value of the pension pot is taken into account; for defined benefit (DB) schemes, there is a formula to calculate the value of the accrued pension.

Annual allowance: This is the maximum amount of pension savings for an individual in their registered pension schemes in a tax year. For DC schemes, this includes employer and employee contributions but not investment returns; for DB schemes, it is based on the increase in value of the accrued pension during the tax year. Some carry-forward is possible and there is a limited carve-out for inflation-based increases to DB deferred pensions. The tax charge for exceeding the annual allowance is broadly designed to recoup the tax relief that would normally have applied to the excess pension saving.

Tapered annual allowance: Individuals with very high incomes can currently see their annual allowance tapered down to as little as £4,000. Very broadly, the taper currently applies to those with 'adjusted income' above £240,000 (this is an individual's taxable income from all sources before deducting any pension contributions they make, plus the value of their employer-funded pension input). The full taper, resulting in a reduced annual allowance of (currently) £4,000, applies to those with adjusted income over (currently) £312,000.

Money purchase annual allowance: When (broadly) an individual accesses their DC pension savings using a flexible option such as drawdown, they become subject to the money purchase annual allowance. This limits the amount that they can contribute annually to a DC arrangement from then on. It was brought in when the 'freedom and choice' pension flexibilities were introduced in 2015, in order to prevent possible abuse of the tax relief system by the 'recycling' of pension contributions (i.e. drawing out money and putting it back in).

Some technical implications of these changes are as follows.

Some individuals have protected personal lifetime allowances higher than the standard lifetime allowance. These protections date back to when the lifetime allowance was introduced (in 2006) and later reduced (in 2012, 2014 and 2016). Some of those protections are lost if there is new defined benefit accrual or contributions are made to a registered pension scheme. Affected people therefore often opt out of pension scheme membership and some employers agree to pay them a cash supplement instead. The abolition of the lifetime allowance means that those protections are no longer needed and so affected individuals can safely join their employer's pension scheme.

Moreover, one of the exemptions from the employer automatic enrolment requirement is where the employer has reasonable grounds to believe that the worker has a relevant lifetime allowance protection. Until we see the Finance Bill, it is not clear how this legislation will be affected. But it could be the case there will be no such grounds from 6 April 2023, and definitely from 6 April 2024, and so some workers will need to be enrolled from the appropriate date where there was previously no obligation.

Most defined benefit pension schemes are currently working through GMP equalisation exercises (correcting sex discrimination issues arising from state pension inequalities in schemes that were contracted-out of the earnings-related state pension). As part of this, there is a choice to be made as to the most suitable equalisation method in the circumstances of the scheme.

The 'GMP conversion' method in particular can result in pension uplifts that trigger the loss of relevant lifetime allowance protections, so this has been a factor for trustees to take into account. The 'deferred member carve-out' (DMCO) which exempts increases to deferred pensions from the annual allowance test, but only up to a point, can also cause issues. With these lifetime allowance protections becoming redundant and the increased annual allowance making the DMCO less of an issue, it will now be easier for some schemes to use the GMP conversion method.

Some employment contracts and/or pension scheme rules limit pension contributions to the standard annual allowance level. This is unusual but where it happens, contributions will in some cases now have to increase.

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