The Lifetime Allowance Charge is being abolished. What does that mean for you?
One of the most striking and surprising announcements in the 2023 Spring Budget was the abolishment of the Lifetime Allowance Charge and the increase of the Annual Allowance for Pensions from £40,000 to £60,000. While the main motivation behind this is to bolster the workforce, this could have many implications for millions of people around the UK.
What was the Lifetime Allowance Charge?
While there is technically no limit to how big your pension can be, there were certain restrictions, with the most notable being the Lifetime Allowance (LTA). The LTA, introduced in 2006 was the maximum amount of pension benefits you could build up in your lifetime, while still enjoying tax relief. Were you to go over the amount, you would be required to pay a tax charge on the excess. This system was focussed on workplace and private pensions, such as Defined Benefit (DB) and Defined Contribution (DC) schemes, while excluding your state pension. In the tax year 2022/23, the lifetime allowance stood at £1,073,100.00, meaning any money you accumulated above that would have a tax charge levied against it. The tax stood at 55% when the excess was taking as a lump sum or 25% when taken as a pension (which you then had to pay further income tax on).
What is the Annual Allowance?
The Annual Allowance (AA) is linked to the Lifetime Allowance, being the maximum amount of pension savings you can accumulate in a year without incurring tax charges. The basic form stood at £40,000 a year and has now been raised to £60,000. Nevertheless, there are two other annual allowance systems: the Money Purchase Annual Allowance (MPAA) and the Tapered Annual Allowance (TAA).
The MPAA is specifically related to DC schemes and comes into question once you start to take money from your DC pension pot. Just like the annual allowance it defines the amount of money you can add to your pension pot, while still enjoying tax relief. If you start taking money, the amount you can still contribute to the pot can reduce significantly. Originally this stood at £4,000, but following the Budget announcement, this has increased to £10,000.
The TAA is a similar system; however, this is specifically related to high earners. Since 2020, anyone with an adjusted income of over £240,000 per year and threshold income of more than £200,000 has seen their annual allowance squeezed. For every £2 they earn over £240,000, they lose £1 of their annual allowance down to a minimum of just £4,000.
The adjusted income level required for the tapered annual allowance to apply to an individual will increase from £240,000 to £260,000 on 6 April 2023 and the minimum amount they can be tapered to will also increase to £10,000.
What has changed?
First of all, in terms of annual allowance measures, these have been noticeably reformed. The annual allowance has now been increased from £40,000 to £60,000 and the money purchase annual allowance and tapered annual allowance have both increased from £4,000 to £10,000. Lastly, the adjusted income level that is required for tapering to apply has increased from £240,000 to £260,000.
In terms of the LTA, the measure will first make sure that no one faces an LTA charge from April 2023 onwards, with the hope to eventually remove it entire from legislation at a future fiscal event.
What is the reasoning behind these changes?
The lifetime allowance had originally been frozen at the aforementioned level until 2025/26. This has changed, however, with the Spring Budget. The government explained the reasoning of this as a measure to reduce the economic inactivity that has been plaguing the UK since the start of the COVID pandemic, with economic inactivity occurring and increasing at a much higher rate in Britain than in other advanced economies. As such, growing the UK labour market and promoting active employment participation are seen as the key to actively growing the UK economy. They believe that the annual allowance and LTA are disincentivising people from remaining in employment. The hope is that, by reforming the former and abolishing the latter, workers considering retirement will be more inclined to remain in employment, while those who are unemployed or already in early retirement may be incentivised to return.
What does this mean?
These changes mainly target people on the wealthier side of the spectrum, with Hunt confirming that the overall idea behind this is ensuring the high skilled workers have an incentive to remain in the workforce. The Chancellor mentioned senior NHS clinicians in the speech, suggesting that the changes will stop over 80% of NHS doctors from receiving a tax charge, making them more inclined to remain in employment at a time when they are needed most.
There are a varying range of perspectives on the impact this will have overall. The Labour Leader Keir Starmer said, ‘this budget changes nothing’, expressing his disappointment, while the Financial Times argues that, while these changes won’t have much impact on most of the general population, it will change everything for pension and financial advisors. Nevertheless, the FT does mention that the new reforms will come with a number of new complications, most notably with the tapering annual allowance. They argue that, for employees, anyone earning enough to be able to take advantage of the new £60,000 limit will almost certainly trigger the limits of the TAA.
This certainly is a monumental change in pension policy and will reform the way pension advisors direct and advise their clients for the foreseeable future.
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