- Pensions savers are in line for a triple boost at tomorrow’s Budget as part of plans to get over 50s back to work, according to reports (Source: Boost for pensions as Hunt ready to raise cap (telegraph.co.uk))
- Chancellor Jeremy Hunt is said to be planning to increase the lifetime allowance from £1,073,100 to over £1.5 million
- The annual allowance could also be hiked from £40,000 to £60,000, while the money purchase annual allowance (MPAA) could rise from £4,000 to £10,000
- AJ Bell wrote to the Treasury last year warning the low level of the MPAA risked running counter to efforts to increase employment levels among older workers
- See end of press release for explainer on the relevant pensions allowances and how they have changed since 2010
Tom Selby, head of retirement policy at AJ Bell, comments:
“After over a decade of persistent cuts to retirement savings incentives by successive governments, this finally looks like it could be a Budget that boosts pensions for hard-working Brits. Reports of senior doctors retiring early due to the impact of pension tax allowances – in particular the annual and lifetime allowance – have undoubtedly been of particular concern to the government given the pressures already on the health system following the pandemic.
“Raising the lifetime allowance beyond £1.5 million and the annual allowance to £60,000 would significantly reduce the risk of NHS staff being hit with a pensions tax charge for working extra hours. However, both the lifetime and annual allowance apply across all types of private pensions and so this announcement would increase the retirement savings limits for millions of Brits.
“It’s worth remembering that in 2010/11 the lifetime allowance stood at £1.8 million and the annual allowance £255,000, so even these increases wouldn’t take us back to those halcyon days. Nonetheless, any rise in allowances would represent a major and welcome departure from recent trends.
“The money purchase annual allowance (MPAA), which applies to those who flexibly access their private pension post-55, is set at such a low level it risks acting as a significant disincentive to work. Given the challenges facing the UK economy this is clearly undesirable, and so raising the MPAA back to £10,000 – the level it was originally introduced at in 2015 – would be a sensible, pragmatic step.”
The case for simplification
“The constant salami slicing of pensions allowances we have seen in recent years have not only reduced retirement savings incentives for Brits directly – they have also created unwieldy complexity which makes explaining the benefits of pension saving unnecessarily difficult.
“There are currently three versions of the ‘annual allowance’, a non-earners allowance, a lifetime allowance and seven different versions of lifetime allowance ‘protection’. Raising three of these allowances would be a positive step in the right direction, but nobody would create a system that looks like this from scratch. As is often the case, complexity has built incrementally over the years.
“As automatic enrolment introduces millions of people to pension saving, many for the first time, there has to be hope that engagement levels will improve. If that happens, we need to make sure the system they engage with makes sense and is relatively straightforward to understand. Ideally, there also needs to be at least some confidence the rules won’t retrospectively change in the future.
“To reach this point, a new independent pensions commission should be formed with the aim of delivering proposals which simplify the system and encourage more people to save for their financial future.”
Background
What is the lifetime allowance?
The lifetime allowance caps the total amount you can save in a pension without having to pay an additional tax charge.
While the current level is just over £1 million, over the years successive governments have whittled the figure down in a bid to raise revenue for the Exchequer (in fact back in 2011/12 the figure was as high as £1.8 million).
Each reduction in the lifetime allowance has resulted in the creation of a new set of ‘protections’, allowing some people to keep a higher personal lifetime allowance.
Your pension savings will be tested against the lifetime allowance when a ‘benefit crystallisation event’ occurs. These events include taking tax-free cash, buying an annuity, entering drawdown, starting a scheme pension (if you have a defined benefit pension) or taking an ad-hoc lump sum (sometimes referred to as ‘UFPLS’).
A test will also be carried out on your 75th birthday if you have funds that haven’t been used to buy an annuity or provide a scheme pension – including any growth your fund has enjoyed if you have chosen to remain invested in retirement in drawdown.
How the lifetime allowance charge works
If you breach the lifetime allowance, a charge will be applied to the excess. This charge will be 25% if the money is left in the pension or 55% if taken out of the pension.
Take, for example, someone who breaches the lifetime allowance by £1,000. If the excess is left in the pension, a 25% charge will be applied, reducing the fund to £750. When these funds are later withdrawn, if income tax is paid at 40%, the amount the person will receive after tax will be £450.
If the person instead takes the £1,000 out as a lump sum, they will pay a 55% lifetime allowance charge (and no income tax), meaning they also end up receiving £450.
For this reason, if you expect to pay less than 40% tax on your withdrawals it can make sense to keep your excess in the pension and pay the 25% charge.
What are the annual allowance and money purchase annual allowance?
The annual allowance limits the total amount you can contribute to a pension without paying a tax charge. This covers personal contributions, employer contributions and tax relief. It is currently set at £40,000 a year.
The money purchase annual allowance applies to anyone who has ‘flexibly accessed’ taxable income from their pension. Once triggered, it reduces your annual allowance from £40,000 to just £4,000. It also removes the ability to ‘carry forward’ unused annual allowances from the three previous tax years.
The term ‘flexibly access’ mainly refers to taking income via drawdown, where your pension is invested and you take an income to suit your needs, or ad-hoc lump sums direct from your DC pot. Taking an income in DB or buying a lifetime annuity won’t trigger the MPAA.
If you breach your annual allowance, you will face an annual allowance charge designed to remove the upfront tax relief your contribution would have received.
That means a basic-rate taxpayer would pay a 20% charge, a higher-rate taxpayer 40% and an additional-rate taxpayer 45%.
Can you access your pension without triggering the MPAA?
There are a few other ways to access taxable income from your pension without triggering the MPAA:
- Just take your tax-free cash. While accessing taxable income flexibly from your pension will trigger the MPAA, withdrawing your tax-free cash won’t. It is possible to ‘partially crystallise’ your fund so you just take out the tax-free cash you need, with the rest left in your fund and able to grow tax-efficiently.
- Take a small pot withdrawal. If your fund is worth £10,000 or less you can withdraw both the tax-free and taxable element flexibly without triggering the MPAA. You must extinguish the entire fund in order not to trigger the MPAA. You can take up to three small pot withdrawals worth £10,000 or less from personal pensions in your lifetime and an unlimited amount from workplace pensions.
- Capped drawdown. Capped drawdown is no longer available, but some savers who were in capped drawdown before April 2015 have remained in it. Provided any withdrawals taken via capped drawdown do not exceed the maximum income limit (150% of the GAD annuity rate), the MPAA will not be triggered.
How have the lifetime allowance, annual allowance and money purchase annual allowance changed since 2010*?
|
Year |
Lifetime allowance |
Annual allowance |
Money purchase annual allowance |
|
2010/11 |
£1,800,000 |
£255,000 |
|
|
2011/12 |
£1,800,000 |
£50,000 |
|
|
2012/13 |
£1,500,000 |
£50,000 |
|
|
2013/14 |
£1,500,000 |
£50,000 |
|
|
2014/15 |
£1,250,000 |
£40,000 |
|
|
2015/16 |
£1,250,000 |
£40,000 |
£10,000 |
|
2016/17 |
£1,000,000 |
£40,000 |
£10,000 |
|
2017/18 |
£1,000,000 |
£40,000 |
£4,000 |
|
2018/19 |
£1,030,000 |
£40,000 |
£4,000 |
|
2019/20 |
£1,055,000 |
£40,000 |
£4,000 |
|
2020/21 |
£1,073,100 |
£40,000 |
£4,000 |
|
2021/22 |
£1,073,100 |
£40,000 |
£4,000 |
|
2022/23 |
£1,073,100 |
£40,000 |
£4,000 |
Source: AJ Bell; HMRC
*Very high earners may be affected by the ‘tapered’ annual allowance, which reduces your annual allowance from £40,000 to as low as £4,000. Whether the taper kicks in will depend on two different income measures – ‘threshold’ and ‘adjusted’ income. You can read more about how the taper works here: AJBYI_Guide_to_annual_allowance_tapering.pdf (ajbell.co.uk)
