Protected Pension Schemes and the Removal of Lifetime Allowance
The Annual Allowance is the maximum amount of pensions savings an individual can make each year with tax relief without incurring a tax charge which aims to effectively recoup some of the tax relief given.
This measure applies to all members of registered pension schemes. From 6th April 2023, it removes the Lifetime Allowance (LTA) charge and limits the pension commencement lump sum (PCLS) to its current maximum of 25% of the current LTA, unless individuals hold a valid LTA or PCLS protection.
The Money Purchase Annual Allowance is a reduction to the Annual Allowance for individuals who have flexibly accessed their money purchase pension savings. The tapered Annual Allowance is a reduction to the AA for individuals with income above set levels. This measure increases the AA from £40,000 to £60,000, and the MPAA and Tapered Annual Allowance from £4,000 to £10,000. It also increases the adjusted income level required for the Tapered Annual Allowance to apply to an individual from £240,000 to £260,000.
The LTA is the maximum amount of tax relievable pension savings an individual can benefit from over the course of their lifetime. Individuals may contribute to their pension over these limits, but they will be subject to a tax charge on the amount above the allowance. The excess is taxed either at 55% where taken as a lump sum, or at 25% where taken as pension. Most individuals are subject to the standard LTA. However, when the LTA was introduced, and each time it has been reduced, protections have been offered to safeguard individuals who had already built-up significant pension savings on the expectation of a certain level of LTA. This measure ensures that nobody will face an LTA charge from April 2023. At a future fiscal event, the government will make the necessary changes to entirely remove the LTA from pensions tax legislation. Consequently, this measure also removes the need for individuals to rely on protections from previous decreases to the LTA.
Individuals may be able to receive to a tax-free lump sum when they become entitled to their pension benefits: a pension commencement lump sum (PCLS). The maximum amount that most individuals can claim as a PCLS is currently 25 per cent of their available LTA at the time this sum is taken. This measure sets a PCLS upper monetary cap of £268,275 (25 per cent of the current LTA). However, those individuals who already have a protected right to take a higher PCLS will continue be able to do so.
For some individuals, lump sums which are tax-free up to the LTA are taxed at 55% on any amount taken above the LTA. This measure ensures that, in such cases, these lump sums are instead taxed at an individual’s marginal rate of income tax.
Who is likely to be affected
Individual members of registered pension schemes who make annual pension contributions over the standard annual allowance (AA), money purchase annual allowance (MPAA), or tapered annual allowance (tapered AA), and who therefore expect to become subject to an AA charge.
Individual members of registered pension schemes who already have or expect to have pension savings exceeding either the standard lifetime allowance (LTA) or their protected LTA, and who therefore expect to become subject to an LTA charge.
Scheme administrators of registered pension schemes who will need to modify their processes to accommodate changes to the AA and LTA.
Inheritance tax angle
From 6 April 2023 some individuals who had obtained protection from 2006 may be able to contribute up to £180,000 into their pension schemes (and £60,000 for each year thereafter). This will be a valuable piece of inheritance tax (IHT) planning because pension schemes are generally not within the scope of IHT. Therefore (subject to available pensionable earnings) such an individual can achieve an immediate IHT shelter for the contributions. In limited circumstances it may also be worth exceeding the contribution allowance even though this would trigger a tax charge. Here I am thinking of circumstances where an individual is receiving a large salary that he does not require and would rather move into the tax-free environment of a pension scheme and out of his IHT estate.
In a similar vein, a shareholder may be concerned about the existence of ‘excepted assets’ (such as excess cash) building up in a trading company. It should be possible to somewhat mitigate this issue if the company were to make employer pension contributions (and here there do not need to be pensionable earnings).
The increases to the AA, MPAA, and TAA will have effect on and after 6 April 2023.
The measures to ensure that no-one will face an LTA charge from April 2023 will have effect on and after 6 April 2023.
The new monetary limit on the Pension Commencement Lump Sum will have effect on and after 6 April 2023.