Pensions announcements in the Budget: tales of the unexpected (and the expected)

• United Kingdom

• Pensions

16-03-2023

In his spring Budget yesterday, the Chancellor announced very significant changes to pensions tax rules, some expected and others unexpected. In a nutshell, these should mean that people can save more into pensions in a tax efficient way. This speedbrief looks at what those changes are, potential implications and some suggested action points.

What was announced in the Budget?

The main pensions measures announced in the Budget were:

From 6 April 2023

• removing the lifetime allowance (LTA) charge

• increasing the annual allowance (AA) from £40,000 to £60,000

• increasing the money purchase annual allowance (MPAA) from £4,000 to £10,000

• increasing the tapered annual allowance (TAA) from £4,000 to £10,000, and increasing the adjusted income from which it starts to apply from £240,000 to £260,000

• fixing the maximum pension commencement lump sum (PCLS) for those without protections at its current level of £268,275 and then freezing it.

Expected from 6 April 2024 (date potentially subject to change)

• full abolition of the LTA (which is currently set at £1.07m)

The meaning of the tax terms above is explained here.

While we focus below on these tax changes, it is worth noting that other measures were announced to try to encourage pensions investment into innovative UK firms. This includes a new “Long-term Investment for Technology and Science” initiative aimed at DC schemes (on which the government is seeking feedback) and pursuing the transfer (by March 2025) of Local Government Pension Scheme assets into pools, to help increase investment in productive assets.

Why are these tax changes being made?

The government wants to encourage people to work for longer. It is concerned about the increase in economic inactivity since the pandemic and believes that current pensions tax rules may be acting as an incentive for some people, particularly doctors, to leave work or reduce their hours.

What are the key implications?

As well as expanding the scope for people to save tax efficiently for their retirement and potentially encouraging some people to work for longer, the changes should help to simplify pensions tax rules. 

The most radical and far-reaching change is the proposed abolition of the LTA from 6 April 2024, which is planned in two stages. First, the LTA charge will cease to apply from 6 April 2023.  Secondly, the government will make the changes needed to remove the LTA entirely from pensions legislation. There are many hundreds of references to the LTA in legislation, and it is interwoven throughout pensions law in a complex way.  So, this will not be simple.  Some pension schemes have also hard-coded the LTA into their benefit structure, so this will also need to be considered.    

It is not entirely clear how the interim period between 6 April 2023 and full LTA removal would work. HMRC has said that, until the LTA is abolished, administrators will need to continue operating LTA checks when paying benefits and issuing benefit crystallisation event statements. So it is expected to be largely “business as usual” for schemes and administrators during this “limbo” period, albeit the LTA charge will not apply to members. 

Yesterday’s HMRC policy paper on pension tax limits gives some more details about its plans – it says, for example, that lump sums above the LTA will be taxed at a person’s marginal rate, rather than at the LTA charge level of 55%. A HMRC newsletter published today also says that members who hold valid enhanced protection or any valid fixed protections (where this was applied for before 15 March 2023 and a certificate or reference number subsequently issued) will from 6 April 2023 be able to accrue new pension benefits, join new arrangements or transfer without losing this protection. They will also keep their entitlement to a higher PCLS. We understand HMRC plans to provide more details in due course. 

There are many potential future knock-on implications of LTA abolition. These could include:

• LTA protections becoming largely (though perhaps not entirely) redundant

• removing some of the problematic tax issues around GMP conversion and loss of LTA protection on certain bulk transfers, particularly buy-outs

• changes to auto-enrolment legislation and processes that allow for those with fixed protection not to be enrolled and re-enrolled

• revisiting pension and life assurance arrangements, particularly any unregistered schemes put in place to address LTA concerns

• some simplification of the process for transfers to qualifying recognised overseas pension schemes, as no LTA test should be required

• a removal of “age 75” LTA tests, which might have wider implications for rules restricting benefit accrual and the application of different tax treatments by reference to age 75.

A potential fly in the ointment is the plan to freeze the maximum PCLS at current levels. This could over time begin to erode the attraction of pension saving for those who build up benefits worth over a million pounds – the concept of the “25% tax free lump sum” would no longer apply to them. HMRC’s policy paper helpfully clarifies that those who already have a protected right to take a higher PCLS will continue to be able to do so. This could get quite complicated.

Comment

After successive cuts to pensions tax allowances over recent years, the increases in the AA, MPAA and TAA thresholds were widely expected in the days leading up to the Budget. The abolition of the LTA was, however, a huge surprise. Together, these changes would make retirement planning easier for members and their financial advisers, though there will no doubt be complications and unforeseen consequences to deal with, particularly around the LTA abolition and PCLS changes.

It is important to strike a note of caution in relation to the LTA – it is likely to take at least a year before full LTA abolition is in force. Much, including a potential change of government, could still change what happens in practice.

The government estimates that the removal of the LTA charge alone will reduce tax revenues by £135m next tax year, so the changes come at a cost. They also do not help the vast majority of pension scheme members, who do not have pension savings worth over a million pounds.

Calls on the government to introduce measures that help those at the other end of the pension savings spectrum (such as raising employers’ auto-enrolment minimum contributions) may now intensify. Could there also be a “quid pro quo” in due course to recoup some of the lost revenue, perhaps in relation to the taxation of death benefits or the minimum age at which pensions can be accessed?

Next steps

Actions for employers and trustees will include the following:

• member communications - tell members asap about the 6 April 2023 changes in the AA, MPAA, TAA and PCLS (and refer to LTA changes, noting that full LTA abolition is still some time away), encourage members to take independent financial advice to understand the implications for their individual circumstances (in particular, some of those planning to take pension benefits now may benefit from waiting until after the LTA charge falls away from 6 April 2023), update out of date references in scheme guides etc

• update administration systems to address changes taking effect from 6 April 2023

• scheme rules – carry out an initial review to identify references to the LTA and any other tax-related provisions that may need amending, followed by a more detailed analysis of the wording and benefit structure once full implications of the changes are clear

• consider existing and future pension and life assurance arrangements, including those (such as excepted life assurance schemes) put in place to deal with LTA concerns, and think about how to address any future pension provision for affected individuals. 

It will take time for the government to confirm the outstanding details and for schemes and employers to work through the consequences. The spring Finance Bill 2023, expected to be published on 23 March 2023, should shed more light on this. However, further issues, questions and unanticipated side-effects will no doubt emerge over the coming weeks and months, as the precise shape of all of these significant changes becomes clear.