Going further than much of the speculation and press briefings beforehand had anticipated, the Chancellor announced three pensions allowance changes in his 15 March 2023 Budget.
What are the pensions allowance changes?
the lifetime allowance (the LTA) charge will be removed from April 2023 with the LTA itself being abolished entirely from April 2024;
from April 2023, the annual allowance (the AA) will be increased from £40,000 to £60,000; and
the money purchase annual allowance (the MPAA) will go up this April from £4,000 to £10,000.
Although the AA and MPAA increases were anticipated, much of the talk prior to the Chancellor’s announcement was that the LTA would also increase, perhaps up to £1.8m, so it comes as quite a shock that it will be removed entirely.
All three changes will be welcomed by the somewhat limited number of pension savers who will benefit, but we will have to wait and see whether the changes will have the desired effect of incentivising the targeted cohort of highly skilled older people to stay in or return to work.
Why are the pensions tax allowances being changed?
The Government’s intention is that by amending the allowances, economic growth will be boosted by encouraging older people (especially those who are highly skilled and experienced and so more likely to have the pensions profile to be impacted by these tax allowances) to return or stay working and have more flexibility around pension savings.
Since the onset of the pandemic there has been a marked increase in ‘economically inactive’ people (6.7m people of working age, excluding students) and older individuals (aged 50 to 64) have accounted for 68.5% of the increase in inactivity between January 2020 to January 2023. Research has found that a disproportionate number of older workers leaving employment come from highly paid professional jobs, some of whom have reportedly cited the allowance restrictions as a reason for leaving. As expressly referred to in the Budget, senior doctors and consultants working in the NHS are retiring early or reducing their working hours because of pensions tax restrictions.
Rising economic inactivity can lead to higher inflation, reduce growth and mean lower tax is paid. The pensions changes are aimed at reversing this inactivity trend, not just for the medical profession but for others who are similarly affected. The NHS is the UK’s biggest employer and the Government refer to around 80% of NHS doctors no longer facing an unexpected tax charge under the NHS 2015 pension scheme because of the measures. For defined benefit pension schemes the value of a member’s pension (or the value of the pension accrued each year for AA purposes) is calculated using formulae set out in the legislation rather than being based upon the level of contributions paid. The Chancellor does not want any medical professional or other worker to retire early because of the way pensions tax works.
What are the different pensions allowances and how are they changing?
The lifetime allowance
The LTA is the total amount a person can save in a registered pension scheme with favourable tax treatment. When introduced in April 2006 it was set at £1.5m, reached £1.8m in 2010/11, was reduced on three separate occasions to an eventual £1m and, following indexation, currently stands at £1.073m. The LTA charge (currently 55% on excess LTA lump sums and 25% for excess LTA non-lump sums) will be removed as from next month and the LTA itself is being extinguished completely as from April 2024.
However, although the LTA itself will be abolished, the cap on the amount of pension savings that an individual can take as a tax-free lump sum at retirement will be frozen at £268,275 (i.e. 25% of the current LTA), other than for individuals with existing protections in place that entitle them to take a higher lump sum. There does not seem to be any proposal for this cap to increase over time (for example, in line with inflation). If so, this cap will therefore reduce in real terms over time and so this could be the first step towards reducing the amount of pension an individual can take tax-free. So, whilst the more penal tax charges for exceeding the LTA are being removed, so is one of the incentives for individuals to make additional contributions that would take their savings above the current LTA.
The annual allowance
The AA is an annual limit on the amount of savings a person can make in a registered pension scheme with tax relief. It is currently £40,000 for the majority but tapered down to £4,000 for certain high earners. At the time of its introduction in April 2006, the AA was £215,000, it rose to £255,000 in 2010/11 but was significantly reduced in 2011/12 to £50,000 and went down again a couple of years later to £40,000. The Chancellor has announced that the AA will increase to £60,000 as from April 2023.
The money purchase annual allowance
This is the annual limit on contributions that can be made in a registered defined contribution (DC) pension scheme if a person has flexibly accessed DC funds on or after 6 April 2015. It is currently £4,000. Making contributions above these limits can trigger tax charges. Going above the MPAA also means that the AA for defined benefit accruals is reduced. The MPAA will be going up to £10,000 as from April 2023.
The minimum Tapered Annual Allowance (which reduces the annual allowance for the highest earners) will also increase in the same way, with the income threshold for this going up from £240,000 to £260,000.
Was there anything else in the Budget about pensions?
Aside from the above headline changes, there was also reference in the Budget to allowing DC pension scheme investment into the UK’s innovative firms. There is an initial package of increased support through the Patient Capital Programme, the creation of investment vehicles in science and tech companies through a Long-term Investment for Technology and Science Initiative and a £364bn transfer of Local Government Pension Scheme Assets in increased innovative company and productive asset investments. Further measures will follow by the autumn.
The Government is also expanding the mid-life MOT initiative, the ‘work, wellbeing, and finance’ review for workers in their 40s and 50s which aims to improve retirement preparation and financial ‘resilience’.
Additional commentary on the pensions tax allowance changes
The successive cuts in all three allowances mean that over time more and more individuals including not just high but middle earners have either exceeded the limits or curbed their pension savings to avoid incurring what can be significant tax charges.
Some will argue that increasing allowances is perhaps not the most effective way to encourage the over-50s to return to or stay in work. Of those not working, not all will wish to or be able to return and might not be persuaded to do so because of tax changes that do not benefit them. Indeed, the Resolution Foundation, an independent think-tank, says that “government policy is unlikely to prompt…[many of these adults]…to ‘un-retire’” and the Institute for Fiscal Studies notes previous research finding that only 5-10% of retired individuals ever go back to paid employment.
There will also be critics who say that the increases only favour a small proportion of individuals largely made up of high earners and there was nothing in the Budget around encouraging lower earning individuals to save more. Government statistics show that in 2020 to 2021, just 58,130 individuals reported having made pension contributions exceeding the AA through self-assessment and 8,610 LTA charges were reported. Although more people are likely to be affected by the MPAA, reaching the LTA and AA affects relatively few because it is generally only applicable for a limited number of members in defined benefit pension schemes that have long service and a comparatively small proportion of the workforce who have the earning capacity that enables them to make large DC pension contributions.
Potential critics aside, there is no denying that the increases will be welcomed by the potentially millions of savers that will benefit and only time (and statistics) will tell whether the labour market responds in the way the Government wishes as a direct result of the tax allowance changes.