In our weekly series, readers can email in with any question about retirement and pension saving to be answered by our expert, Tom Selby, head of retirement policy at investment platform AJ Bell. There is nothing he doesn’t know about pensions. If you have a question for him, email us at [email protected].
This week’s question is from reader, Stephen. “Can you explain the key pensions measures from the Budget and how they will affect people? And what happens if Labour comes in and reverses it all?”
Tom’s reply: Jeremy Hunt’s first Budget as Chancellor delivered a series of big changes for pensions taxation which will boost retirement savings allowances for millions of people.
The headline change was about the lifetime allowance, which currently controls the total value of pension benefits someone can build up without being subject to a tax charge over their lifetime. Today, if you breach the lifetime allowance, which stands at £1,073,100, you will pay a lifetime allowance charge on the excess. This charge will be 25 per cent if the excess is taken as income and 55 per cent if taken as a lump sum.
However, from 6 April 2023, the lifetime allowance charge will be reduced to 0 per cent, with the Government eventually intending to scrap the lifetime allowance altogether.
This will dramatically simplify pensions saving decisions for those close to or over the lifetime allowance and, crucially, remove the disincentive to take investment risk for anyone worried about being hit with a lifetime allowance charge as a result.
As part of the changes, the maximum tax-free cash someone can take will be held at £268,275 – a quarter of the current £1,073,100 lifetime allowance.
The amount of lifetime allowance you have used is “tested” when a “benefit crystallisation event” occurs. The main benefit crystallisation events are:
- Taking your 25 per cent tax-free cash;
- Entering drawdown (where your pension is invested and you take an income to suit your needs);
- Buying an annuity (where you secure a guaranteed income from an insurance company);
- Taking an ad-hoc lump sum directly from your retirement pot;
- Turning age 75;
- Death (if you die before age 75).
While clearly the final two are not in your control, if by crystallising your pension (or part of your pension) you will have used up all your lifetime allowance, it makes sense to hold off doing so until 6 April if you can. If you crystallise your pension before 6 April, your fund will be tested against the lifetime allowance and you could still be hit with a lifetime allowance tax charge as a result.
There are also various forms of lifetime allowance “protection” that have been introduced since 2006 which allow those who applied for them to retain a higher lifetime allowance and, in some cases, a higher tax-free cash entitlement.
These protections will be honoured under the new reforms, meaning if, for example, you have a tax-free cash entitlement higher than £268,275, you will be able to keep it. What’s more, you will be able to top-up contributions from 6 April 2023 without losing any protected tax-free cash entitlement you have.
If you are at all uncertain about how any of this applies to you, it’s worth speaking to a regulated financial adviser.
Annual allowance boosts
As well as setting out his intention to scrap the lifetime allowance, the Chancellor also announced significant boosts to pensions annual allowances. These govern how much can be paid into a pension each tax year before an annual allowance charge is levied.
The main annual allowance, which covers personal contributions, employer contributions and tax relief, will rise from £40,000 to £60,000 from 6 April this year. In addition, the minimum level of the tapered annual allowance, which affects very high earners, will increase from £4,000 to £10,000.
At the same time, the money purchase annual allowance, which is triggered when you “flexibly access” taxable income from your retirement pot, will rise from £4,000 to £10,000.
“Flexibly accessing” your pension primarily means taking taxable income from your pot via drawdown or an ad-hoc lump sum direct from your fund. If you take an ad-hoc lump sum, a quarter of the withdrawal will be tax-free, with the rest taxed in the same way as income.
If you breach any of these annual allowances, a tax charge will be applied to the excess designed to remove the upfront tax relief your contribution received.
One final thing to note is that pensions are now even more attractive from an inheritance tax (IHT) perspective as a result of the Budget.
If you die before age 75, your pension can be passed on completely tax-free to your nominated beneficiary (or beneficiaries), while if you die after age 75 it will be taxed in the same way as income when your beneficiary makes a withdrawal.
From 6 April onwards, the reduction in the lifetime allowance charge to 0 per cent means pensions of any size could potentially be inherited completely free of tax.
What if the LTA abolition is reversed?
Lots of people are already worrying about whether Labour could reverse this decision if they win the next general election. Some might even be thinking about taking decisions with their pension to mitigate against this risk.
Second-guessing what a politician may or may not do if they win power is a fool’s game and certainly isn’t something you want to be hanging your financial future on. There is also a risk that in trying to dodge something which is entirely uncertain, you end up making a poor financial decision.
We have no idea what a Labour reversal of this policy would look like or if they would follow through with it, so rather than being distracted by politics, deal with the tax rules as you find them and stay focused on your long-term retirement strategy.