As discussed in our Spring Budget 2023 blog post, the Chancellor of the Exchequer, Jeremy Hunt, last week announced sweeping changes to the personal tax regime for pensions. The purported aim of these changes is to retain skilled professionals – notably senior NHS doctors and consultants – in work and to incentivise early retirees to return to the workplace, although vocal doubts have been expressed about the likely effectiveness of these measures in achieving that aim.
This blog post summarises the key announcements and their implications on employers, trustees and individuals.
What are the changes?
- Annual Allowance (AA). The AA is the cap on ‘tax-free’ annual pension contributions, which has been frozen for almost a decade. This will increase from £40,000 to £60,000 p.a. from 6 April 2023. Individuals will continue to be able to carry forward unused AAs from the three previous tax years, meaning they could pay in a total of £180,000 next tax year.
- Money Purchase Annual Allowance (MPAA). The MPAA is the amount of ‘tax-free’ money that individuals can contribute to their defined contribution pensions after they have started flexibly accessing them. This will increase from £4,000 to £10,000 p.a. from 6 April 2023.
- Tapers Annual Allowance (TAA). The minimum TAA will increase from £4,000 to £10,000 p.a. from 6 April 2023. The TAA is the mechanism by which the AA for individuals who meet certain threshold income and adjusted income requirements gradually reduces by £1 for every £2 of adjusted income above a threshold. The adjusted income threshold for the TAA will also be increased from £240,000 to £260,000 from 6 April 2023.
- Lifetime Allowance (LTA). The LTA is the 'tax-free' cap on how much an individual can build up in pension benefits over their lifetime. From 6 April 2023, the LTA (charge will be removed, and the LTA will be fully abolished in a future Finance Bill.
- Pensions Commencement Lump Sum (PCLS). The maximum PCLS (the ‘tax-free’ amount of money available as a lump sum when a member takes their benefits) for those without protections will be retained at 25% of the current LTA (£268,275) and will be frozen thereafter.
What are the effects of the changes on individuals?
The changes have been criticised as aiding the top earners in the country. While it is clear that the changes will not make any difference for the vast majority of pension savers on lower and middle incomes, those affected by the reforms will now be able to continue to contribute to their pension pots without worrying about a future LTA charge and may even delay their retirement as a consequence. This may include diligent savers in middle-income brackets who are close to retirement.
However, some commentators have voiced concerns about the Chancellor’s changes. For example, individuals who have already dipped into their pension pots will still be subject to the MPAA. While this cap will increase to £10,000, it is still far less than the £60,000 AA for those that have not yet accessed their pension. Additionally, those who can take advantage of the newly increased AA will still likely be limited by the TAA, even at its newly raised threshold. This means that they will still be limited to £10,000 per year contribution to their pension, limiting what many have claimed to be significant tax giveaways for the highest earners. Further, even though the LTA will be abolished, the current PCLS limit will remain in place, so that the value of the lump sum in real terms will be eroded by inflation over time. This is likely to mean that the attractiveness of the PCLS will be greatly reduced unless this is revisited at a later stage.
At present, the potential impact of the announcements is significantly affected by political uncertainty. Labour leaders have stated that they would reverse the LTA changes if they win the upcoming general election. This will make pensions planning difficult for affected individuals, particularly if there is no assurance that existing protections will be grandfathered in some way.
For example, an individual who took out fixed protection (which allowed them to retain their LTA at a higher level when the LTA was previously reduced) would have stopped making pension contributions once their fixed protection was put in place, so will have lost out on building their pension through that time, a loss which they cannot now fully retrospectively address (as AAs can only be carried forwards three years).
Further, whilst they could now build more pension using the new AA and other increased thresholds, it is unclear what might happen if the LTA abolition is subsequently reversed. Would everyone go back to a cap of £1m (as if fixed protection never happened), would prior fixed protection be reinstated but only if people had continued to comply with the fixed protection terms (such as no contributions), or would Labour propose a brand-new grandfathering protection mechanism?
HMRC has provided some clarity in its recent Pension Schemes Newsletter, which confirms that members holding valid enhanced or fixed protections will be able to accrue new benefits, join new arrangements or transfer without losing those protections if they were applied for before 15 March 2023. Further, members with a protected right to a higher PCLS will keep their entitlement. Despite that, many questions remain unanswered, particularly as to what a Labour government might do.
What are the effects of the changes on employers and trustees?
The announcements will not only affect individuals saving for retirement. Retail pension providers, sponsoring employers and trustees of occupational pension schemes will have to be vigilant in ensuring that their scheme rules reflect the reforms, modifying their processes to accommodate the changes and keeping up to date on the requirements if and when they evolve. Members will also need to be provided with new information and guidance to understand the impact on their pensions.
As an example, at the moment, where members have LTA or AA issues, they may receive a cash in lieu payment. Those arrangements may need to be revisited by schemes as members may now have additional headroom in their ability to make pension savings.
Separately, there are various exercises, such as GMP equalisation and correction of historic administrative issues, which will now be simpler as a result of the Chancellor’s changes. These exercises can take place on a standalone basis but may be particularly relevant where they are undertaken in the context of de-risking exercises such as buy-ins and buy-outs. Similarly, the effect of the changes will potentially be to simplify de-risking exercises where those protections might otherwise have been lost.
While the announcements of the Chancellor’s reforms will be welcome news for some, the unanswered questions will leave many wary. Pensions is a long-term financial planning tool, so individuals need reliable and consistent rules in order to plan effectively. Ultimately, the devil will be in the detail. Some (but not all) of that will be introduced in future Finance Bills, and (relative) certainty may not be achieved until after the next general election.