Pensions tax changes: What you need to know
By Susan Cattell, Head of Tax Technical Policy
16 March 2023
Susan Cattell outlines some important pensions tax changes announced by the Chancellor in his Spring Budget.
Problems looking for a solution
As the Chancellor acknowledged in his Budget speech, some aspects of the taxation of pensions, have been causing problems, particularly in the NHS. He cited concerns raised by senior clinicians, who told him that unpredictable pension tax charges are making them leave the NHS. However, he also recognised that the issue goes wider than doctors, suggesting that “no one should be pushed out of the workforce for tax reasons”.
The main areas of difficulty addressed in the Budget were:
Lifetime allowance (LTA): This is the limit on total tax relieved pension savings. It had reduced in stages from £1.8m in 2011/12 to £1m in 2016/17. Prior to the Budget it was £1,073,100 and was expected to be frozen at that level until April 2026. Unsurprisingly, some of those affected by the LTA were opting to retire early, or reduce their hours, to avoid punitive tax charges for exceeding it.
Annual allowance (AA): This sets an annual limit for tax-relieved pension contributions. It was £50,000 in 2011/12, but reduced to £40,000 for 2014/15 onwards. Due to the operation of the NHS pension scheme, the government noted that this was giving rise to unexpected tax charges for many doctors. Outside the NHS it could mean a lack of flexibility, for example, those with variable incomes who would like to be able to make larger contributions in some years.
Money purchase annual allowance (MPAA): Individuals who have already accessed their pension pots are subject to a reduced allowance for pension contributions. This was £10,000 in 2016/17 but reduced to £4,000 for 2017/18 and subsequent years.
Through the changes announced, the Chancellor hopes to remove a deterrent to experienced and skilled individuals remaining in the workforce and to encourage some of those who may have retired early, to return to work.
Budget changes
Lifetime allowance
The government announced that from 6 April 2023 the LTA charge (applied where the LTA was exceeded) will be removed. The LTA will be fully abolished from the 2024/25 tax year (this will be included in a future Finance Bill).
HMRC has published Pensions scheme newsletter 148 setting out some complexities arising from this two stage approach, and how pension scheme adminstrators should deal with the changes. This includes information on pension commencement lump sums and other lump sums.
Annual allowance
The government announced that from 6 April 2023, the AA for tax relief on pension savings in a registered pension scheme will increase from £40,000 to £60,000.
The adjusted income limit has not been removed, but will increase from £240,000 to £260,000. This means that if a pension scheme member’s adjusted income is over £260,000, their AA in the tax year may be reduced. For every £2 their adjusted income exceeds £260,000, their AA for the current tax year will reduce by £1. The minimum reduced AA from 2023/24 onwards will be £10,000 (increased from £4,000).
Money purchase annual allowance
The MPAA will revert to £10,000 from April 2023 (increased from its current level of £4,000).
ICAS reaction
Pensions require long term planning, so the numerous reductions to tax allowances in recent years undermined confidence, made sensible planning difficult and had adverse consequences in discouraging some individuals (including doctors) from remaining in the workplace. However, without any political consensus on a long-term approach to the pensions tax regime, we envisage that individuals will continue to find it difficult to make important decisions about retirement and pensions, against a backdrop of ongoing instability.
The Chancellor clearly hopes that abolishing the LTA will remove a deterrent to those individuals (including doctors) continuing to work. How effective this will be, may depend on whether those affected believe abolition is likely to be reversed.
We support tax simplification, and the abolition of the LTA would certainly be a significant simplification of a very complex pensions tax regime. However, any simplification benefit would be lost, if lack of cross-party consensus means that a future government reverses the change.
The Chancellor highlighted that the increase in the AA from £40,000 to £60,000 would have a particularly important impact on the NHS, although this will of course depend in part on what happens to the LTA in the longer term. However, the additional flexibility could assist others, for example, those whose variable incomes mean that they can afford large contributions in some years but smaller, or no,contributions in others.
Where individuals have already retired and accessed their pension pots but now return to work, as the Chancellor hopes some of them will, they are likely to want to make additional pension contributions. Increasing their tax relievable allowance from £4,000 to £10,000 is unlikely to be a decisive factor for many, but it might be an added incentive for some to return to the workplace.
We recommend that the Chancellor might want to consider uprating any pensions allowances in line with inflation each year, so that they do not lose their value over time.
Looking beyond the tax regime, we know that many people in the UK are not saving enough towards their retirement – see, for example, research from the Pensions and Lifetime Savings Association. We would like to see the government take steps to address the needs of those working people whose savings are insufficient to produce an adequate level of income in retirement and those who do not have access to a workplace pension (for example, the self-employed). This could include changes to the legal and regulatory environment to encourage the pension industry to focus on providing pension savers with good outcomes in retirement.
On tax, it is vital that government policy on pensions provides stability, to avoid uncertainty for individuals and unwanted consequences, like those arising from the frequent reductions to allowances in recent years. We would like to see cross-party agreement on the need for a long-term strategy and a willingness to cooperate in developing it.
Let us know your views
We welcome members’ input on consultations or other tax-related matters – email tax@icas.com to share your insights and feedback. ICAS responds to many tax calls for evidence and consultations, as well as producing tax policy papers and reports. We also regularly attend meetings with HMRC at which service levels, delays and other issues are discussed, and we raise problems being encountered by members.