Pensions tax changes in the 2023 budget
The Chancellor’s budget statement on 15 March caused many to be surprised and some to be perplexed. His budget saw changes to:
- the annual allowance (AA) - the maximum amount of pensions savings an individual may make each year without incurring a tax charge;
- the lifetime allowance (LTA) - the maximum amount of pension savings an individual can benefit from over the course of his or her lifetime without incurring a tax charge;
- the money purchase annual allowance (MPAA) - the maximum amount of pensions saving an individual who has already flexibly accessed his or her pension savings may make each year without incurring a tax charge;
- the adjusted income level which relates to higher earners and which results in a reduction in the annual allowance – the adjusted level income will increase from £240,000 to £260,000; and
- the tax free lump sum which will cease to be expressed as a percentage (25%) of an individual’s pension savings and which will be capped at 25% of the existing LTA.
The AA and LTA were introduced in 2006 to limit tax-efficient pension savings in registered pension schemes. The original limits were £215,000 for the AA and £1.5m for the LTA. The MPAA was introduced in 2015 when pension freedoms came into force allowing members of defined contribution schemes to access their savings pots flexibly. The MPAA is designed to prevent people from recycling those pension savings.
An answer to calls for reform
The past few years have seen increasing pressure on the Government to reform the AA, LTA and MPAA. Matters appeared to come to a head when the pandemic arrived in earnest in March 2020 and the usual course of UK business was subject to sudden and unparalleled change. Broadly, during the pandemic, there was an increasing amount of evidence to suggest that senior employees in the public sector (particularly senior NHS employees) were reducing their working hours or stopping them altogether to take early retirement - in order not to trigger the sort of tax charge incurred when one exceeds the AA or the LTA.
Whilst media reports often focus on the pounds, shillings and pence aspects of the AA and LTA, it is fundamental to understand that where an individual has a defined benefit pension scheme, which are all but extinct in open form in the private sector, but which remain a standard part of the public sector benefits package, it becomes necessary to capitalise the value of the entitlement to accrued benefits or pension to work out if you have breached the allowances or not. Contributions are irrelevant and in the vast majority of cases the public sector schemes are unfunded in any event. Because these benefits are so valuable and increase in value with each year of pensionable service, it is possible to breach the allowances more easily and without knowing you have done so (unless you are an actuary as well as a doctor for example – which would require quite a combination of skills).
The AA and the MPAA
The AA is currently £40,000 per annum (although complex tapering provisions apply to higher earners which can reduce it significantly). The penalty for exceeding the AA is to be taxed at one’s marginal rate of income tax in relation to the excess (the excess is effectively treated as your top slice of income and so brought back into the income tax charge).
According to reports by (amongst others) the Financial Times during the pandemic, many senior doctors and clinicians fell foul of the AA after agreeing to work longer hours. It was a case of the law of unintended consequences, but one which caused many senior clinicians to incur punitive tax charges (which they did not necessarily realise they were incurring because, as noted above, the charge has nothing to do with the amount they were contributing into their public sector pension scheme, which must have resulted in some interesting discussions when it came time to complete the annual tax return).
The AA will increase with effect from 6 April 2023 from £40,000 to £60,000 with the income abatement level starting at £260,000 (up from £240,000). This means that the cap for those with income in excess of £312,000, now increase from £4,000 p.a. to £10,000 p.a.
The MPAA is a reduction to the AA for those individuals who have already flexibly accessed their money purchase pension savings. It is arguably the easiest of the allowances to breach and has been a significant contributor to HM Treasury revenues over the last 13 years. Those returning to work (having accessed their pension savings flexibly) are now able to contribute up to £10,000 to a pension plan – an increase from £4,000. Many commentators, including the writer’s consider this change, apparently the smallest, to be the most significant, as it will remove the restrictions that many were facing, particularly in the private sector where money purchase pension schemes are more prevalent.
The LTA is currently £1.073m. Where the value of an individual’s pension savings is higher than the LTA, he or she has to pay a tax charge assessed as 55% of the excess above the LTA or 25% of the excess where the entire benefit is taken as pension.
The Chancellor evidently had the law of consequences (unintended or not) in his mind by ensuring that the abolition of the LTA did not mean that an individual could, at retirement draw 25% of an unlimited amount by way of a tax free lump sum (or pension commencement lump sum (PCLS)). The PCLS will therefore be capped at £268,275 from 6 April (2023). That said, individuals with protected rights to take a higher PCLS will not lose that right by virtue of the new policy.
Many commentators expected the LTA to be increased, with the strongest rumour being that the LTA would increase to £1.8m (which was the LTA’s highest limit in 2011-12). Nobody seemed to have foreseen its abolition. HM opposition was surprised enough to suggest that it would reverse the Chancellor’s decision if it were elected. The Institute for Fiscal Studies, which estimated that the decision would “cost” HM Treasury approximately £4bn over five years (although Government documents indicate that the decision will cost £2.75bn over the same period) suggested that the decision was “bizarre”.
Impact of these changes
Readers old enough to remember a television series called “Blackadder” (a programme which, at the time of its broadcast, had a cult following) will remember a character from that series called “Baldrick”. Baldrick, played by actor Tony Robinson, invariably started his description of his latest strategy with the words “I have a cunning plan...”. The expression “I have a cunning plan…” became so well-known that it was used by writers and commentators who had probably never watched a complete episode of “Blackadder”. When one journalist wrote a piece in the late 1980s about British chancellors of the exchequer and observed that many started out as Napoleons but ended up as Baldricks, his comment required no explanation.
In his budget statement, the Chancellor explained that his own cunning plan in abolishing the LTA is to solve the problem of senior public service employees taking early retirement or cutting back their hours of work in order to avoid the punitive tax consequences of paying, or in the majority of cases accruing, too much into their pension plans.
The decision will, we consider, have been welcomed by senior NHS clinicians although HM opposition’s reaction has also created a sense that the abolition may be temporary and its value should be set off against the estimated (by the Institute of Fiscal Studies) £8bn (per year) HM Treasury has collected since 2010 as a result of breaches of the LTA, AA and MPAA.
If the issue is largely confined to public sector pensions, because they are of the defined benefit type, then the Chancellor’s approach raises some questions as to whether a more tailored approach could have been employed, perhaps by reducing the value at which defined benefit pension schemes capitalise their value for the purposes of the AA and LTA (at the moment there are some magic numbers which enable you to do this but there is no reason this could not be worked out in a different way which would reduce the capital value) or excluding certain professions from the LTA and AA (such as happened in the case of Judges in the Judicial Pension Scheme).
There is also a chance that discussion over these points will eventually spark a wider debate, which surely has to come as some point, about the continuation of generous private sector defined benefits (as it seems that the public sector is simultaneously beset with being poorly paid and having pension schemes which risk breaching limits which are beyond the dreams of most people working in the private sector).
For those of us who aren’t senior clinicians or judges, the changes are not likely to have a significant an impact. Reporting on 15 March, the FT noted that an average 65 year old’s pension savings account contains £87,500. This gives perspective to the reform by indicating that neither the LTA nor the AA are much more than an irrelevance to most of the population. It follows that abolishing the former and increasing the latter by 50% is unlikely to cause those other than the better off to celebrate.
How will this all work?
In summary, legislation will be introduced to:
- increase the AA from £40,000 to £60,000;
- increase the MPAA from £4,000 to £10,000;
- increase the adjusted income level for the tapered AA to apply from £240,000 to £260,000;
- make sure that no individual will face a LTA charge from April 2023;
- limit the maximum an individual can claim as a PCLS to 25% of the current LTA (£268,275), except where protections already apply and would result in a higher PCLS; and
- remove the LTA from pensions tax legislation.
We await the legislation itself with interest.
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