A cap that fails to fit? (Birmingham Post article 30.03.2023)

The Spring Budget brought a good, the bad and the ugly to pensions.

The good being a freeing up of savings restrictions, the bad evincing a sting in the tale, and the ugly highlighting fears for the tax-free allowance.

First, the positive …

Previously, tax-free contributions to pensions were typically a maximum of £40,000 a year – the annual allowance – while a £1,073,100 limit applied on the total that could be held in a pension, the lifetime allowance.

Now, a new annual allowance of £60,000 applies from April followed by the complete removal of the lifetime allowance later this year.

In addition, the adjusted income threshold for annual allowance tapering rises from £240,000 to £260,000. Adjusted income is your annual income – broadly everything you are taxed on including dividends, savings interest and rental income – before tax plus the value of your own and any employer pension contributions. The annual allowance reduces by £1 for every £2 that your adjusted income is in breach, down to a cut-off figure of £10,000, up from £4,000, meaning that individuals can total £360,000 before it applies to them.

This tapered reduction does not apply to those who have ‘threshold income’ – excluding pensions – of no more than £200,000.

The money purchase annual allowance (MPAA), which applies once taxable income has been accessed from a pension, will rise from £4,000 to £10,000.

Fidelity noted: “The Chancellor is hoping the changes can help tackle the problem of older workers leaving the workforce. That trend has been particularly acute in professions like medicine where senior staff have hit the lifetime allowance and chosen to give up work because any extra hours are much less valuable to them.

“The removal of an upper lifetime limit also hands pension holders extra shelter from Inheritance Tax because money held in a pension is usually exempt.”

Interactive Investor called the changes “a breath of fresh air”, going on: “With life expectancies rising, more of us will need to finance a long retirement.

“The sigh of relief is almost audible as pension savers celebrate the scrapping of the hugely unpopular lifetime allowance.

“The simplifying of the rules will help, not only more wealthy investors, but those with modest pension savings who won’t have to worry any more about their pension being hit with high tax charges if their investments perform well. It was surprisingly easy to breach the old LTA limit, especially after a long working life with regular pension investing. Someone starting work at 20 and saving £500 per month until they reach retirement age at 68 could see their pension pot reach an amazing £1.2 million as even modest pension savings add up. This was putting people off saving into their pension.”

Good news … but then we come to the bad.

Jon Greer, head of retirement policy at Quilter, told FT Adviser: “Hidden in the documents is a sting that people will now only be able to take 25 per cent tax-free cash from their pension subject to a maximum of £268,275. So even if someone has a pension pot far bigger than the previous LTA this will be the most they can take out. However, those who have existing rights to higher tax-free cash amounts will retain them.”

And on to the ugly …

Interactive Investor’s head of pensions and savings Alice Guy said the tax-free lump sum cap would now in effect be a separate entity, with the potential it could be reduced in the future, and meanwhile worth less and less over time due to inflation. “This change may turn out to be a huge disincentive to some pension savers and it may erode one of the simplest and best-loved pension rules.”