Pension Allowances
The Chancellor, Jeremy Hunt announced in his Budget changes to pension limits, increasing the amount you can save into pension and abolishing the Lifetime allowance (LTA) which is the maximum amount that you can accumulate in your pension tax efficiently.
Annual Allowance
The annual allowance is the total amount of savings that can be added to your pension each year. From the 6th April 2023, this is increasing from £40,000 per year to £60,000 per year.
The annual allowance includes both employee and employer contributions.
For defined benefit (Final Salary schemes) the annual allowance figure is based upon a growth figure calculated using a factor and is more complicated than a money purchase type arrangement.
Lifetime Allowance
The Lifetime Allowance was introduced in 2006 and restricted the amount of tax efficient fund that you could accumulate to £1.5m. Any amount over this would suffer a lifetime allowance tax charge.
The limit increased to £1.8m in 2010, before being reduced to £1,073,100 in 2020 where it has stayed ever since.
For money purchase pensions this is the value of the pension pot. For defined benefit pensions to calculate the value of the pension for LTA purposes, the pension that you are entitled to is multiplied by a factor and usually you add on the lump sum figure to arrive at the value.
The Chancellor has abolished the LTA which is good news for pension savers.
Pension Commencement Lump Sum (commonly known as Tax-Free Cash)
Whilst there is no longer a limit on the value of your pension fund, there is a limit on how much you can receive as tax free cash. This is usually 25% of the value of your pension pot, however the government have restricted this to 25% of the LTA of £1,073,100 resulting in a maximum tax free cash figure of £268,275.
Existing Protections
In the past, there have been a number of ‘Protections’ for those whose pension would be over the LTA at the time of introduction and when the LTA figure was reduced.
Although the LTA has been abolished, care should be taken as if you pay into pension again, you will lose your protection and potentially entitlement to a higher level of tax-free cash than the new limit of £268,275.
For those in this position, there are alternative investment options which provide tax efficiency.
Pensions and Inheritance Tax Planning (IHT)
Money purchase pension arrangements do not usually form part of your estate and are not therefore subject inheritance tax. With the increase in the annual allowance and the abolition of the LTA, they can be a very valuable option for IHT planning.
Summary
The announcements are welcomed and will help many people save towards the retirement that they desire.
But it’s complicated and it’s important that you seek independent financial advice to help guide you through the options and implications before you take action to avoid an unintended costly mistake.