Here we go again!

I have been in this industry since 1987 and the two main things I have learned during that time is that change is inevitable, and simplification often means complication.

Before starting this article, I tried to remember/look up the number of changes to pensions legislation in those 30 something years and to be honest I lost count and interest once I got to 25!

The chancellor, Jeremy Hunt’s, Spring Budget 2023 announcement to abolish the Pensions Lifetime Allowance was a big one. Right up there with Steve Webb opening up flexible access to pension pots in 2015.

So why do pension restrictions keep changing? Clearly there can be political motives, but the reality is they can be a very tax efficient way of saving and passing on wealth. In 2021/2022, pension income tax relief alone cost the exchequer over £50bn.

In order to understand the potential effect of the changes, it is probably best to remind ourselves of the current tax position and advantages of investing in pensions. To try and simplify things, and you will remember what I have learned about simplification, we will just concentrate on Personal (money purchase) Pension Schemes here:

Tax Advantages

Tax relief on contributions: An individual can claim tax relief on contributions to their personal pension. The tax relief is available at the individual’s highest rate of income tax. For example, if an individual is a higher rate taxpayer and makes a contribution of £1,000, then the government will add £250 tax relief to the pension pot, at source and in addition, the taxpayer can claim a further £250, marginal rate tax back. The net effect is that a £1,250 investment in the pension will cost only £750.

Tax-free growth: The investments held within the personal pension plan grow free from UK income tax and capital gains tax.

Tax-free lump sum: On reaching the age of 55 an individual can take up to 25% of their pension pot as a tax-free lump sum.

Taxation

Income tax on withdrawals: Any withdrawals taken from a personal pension plan, above the tax-free 25% (Pension Commencement Lump Sum PCLS), are subject to income tax. The amount of tax payable will depend on the individual’s other sources of income and their tax bracket when they take some or all of the pension.

Inheritance Tax: All funds in the pension are exempt from Inheritance Tax (currently 40% for taxable estates).

Income Tax on Death: If a person dies before the age of 75 with funds still held within their personal pension plan, then these funds can be passed on to beneficiaries, free from inheritance tax and income tax. On death after age 75, the income tax will be based on the beneficiary’s tax position.

Looking at a hypothetical, if not necessarily the most pleasant extreme, an additional rate (45%) taxpayer who accumulates a pension pot of say, £500,000 and dies before age 75 could pass the whole lot on, free of tax, would have invested only £275,000 and could have avoided a further £110,000 in Inheritance tax. I have ignored any growth here to make the numbers easier but hopefully you will get what I mean.

I will not confuse you with the additional National Insurance Savings that can be obtained through company contributions or salary sacrifice.

So, you can see the problem.  With all these tax advantages sloshing around, successive governments have sought to control the amount of money we can save into pensions (25+ attempts and rising!) and up until 6th April 2023, this was through two main restrictions:

Annual Allowance: A limit in the amount of pension contributions that an individual can make per year, which is currently £40,000. This is however reduced down to £4,000 (the money purchase annual allowance – MPAA) for high earners and those who have already flexibly accessed their pensions above taking the PCLS.  

Lifetime Allowance: The maximum pension savings that you can accumulate over your lifetime. In excess of this there is a tax charge of 55%, if taken as a lump sum, or 25% if taken as income (remembering that this income would also be taxed if drawn out).

The current Lifetime Allowance is £1.073m but since it was introduced in 2006/07 it has changed 11 times, peaking at £1.8m. In each case of reduction, pension holders were able to claim protection for the previous higher rate, but only if they stopped any future contributions.

So, what has changed?

As you can imagine, pension holders were left in a world of confusion and often unfair penalisation. The limits have affected certain professions particularly badly (like doctors and dentists) and have potentially prevented people re-entering professions. One could also argue that, the more people have to spend in retirement, the more society as a whole will benefit, directly or indirectly. As a result, Jeremy Hunt has made significant changes:

Annual Allowance: This has been increased by 50% to £60,000, with the MPAA also rising to £10,000 (which was where it was before it got reduced in 2019/20!)

Lifetime Allowance: Here is the big one! It had been widely leaked that this allowance would be increased back to £1.8m but in one of those rabbit out of the hat moves that chancellors love, it has been totally abolished.

Tax-Free Cash: This has been restricted to the lower of 25% or £268,275, being 25% of the current cap. Funnily enough the Chancellor did not announce this bit. We had to wait for the small print for that!

So, what does this all mean?     

It means that pensions are back on the table for many people who had been shut out, and the doors to tax efficient saving, income and wealth transference have been flung back open. There are however a lot of considerations and individual number crunching to be done to work out the optimal position. Pensions are not the only option and a proper financial plan, utilising a range of investments and tax wrappers, will help deliver the best financial outcome.

Once again though, simplification may have made things more complicated and whilst there are potential benefits here, there are also pitfalls. Unsurprisingly, I would suggest that you take professional independent advice. You may say that I would say that wouldn’t I, but over the years I have seen many simple mistakes made that have led to consequential losses of both tens and hundreds of thousands of pounds. As advisers we spend our lives working out jigsaws like this. For those of a certain age, like me, in the words of the A-Team’s Hannibal Smith, we ‘love it when a plan comes together’.

And what did I say about change? Well Shadow Chancellor, Rachel Reeves, has already stated that her Labour party will reverse these decisions if they win power. Whilst there can be no guarantees, I would remind you of previous protections, and so I would suggest looking at the options fully, and sooner rather than later would be sensible.

What next?

To discuss these changes in more detail and how they impact you, please speak to Chris Clayton or your usual CBW Financial Planning contact.