Spring Budget 2023 – important changes to pensions taxation

The Spring Budget contained several major announcements affecting pensions taxation.

Lifetime allowance

What is happening? The lifetime allowance (LTA) will be abolished from 6 April 2024. In the meantime, the LTA charge will be removed from 6 April 2023. The abolition of the LTA charge will also mean that, from 6 April 2023, where a serious ill-health lump sum, defined benefit lump sum death benefit or uncrystallised funds lump sum death benefit exceeds the LTA, the excess will be taxed at the recipient’s marginal rate rather than 55%.

What is the LTA? As a reminder, the LTA is the maximum amount of tax-relieved pension savings that an individual can make over their lifetime. When originally introduced in 2006, the LTA was set at £1.5 million. It is currently £1.073 million. When first introduced, and each subsequent time it was reduced, individuals with savings in excess of the LTA (or reduced LTA, as applicable) were able to apply to retain a higher “protected” LTA. In most cases, the individual loses their LTA protection if they make further pension savings. The LTA charge is payable when benefits are taken whose value exceeds the LTA. It is payable on the value that is in excess of the LTA, at a rate of 55% where the excess is taken as a lump sum and 25% where the excess is taken as pension.

How are pension commencement lump sums impacted by the LTA change? When taking their pension benefits, individuals can take a tax-free pension commencement lump sum (PCLS). In most cases, the maximum PCLS that can be taken is the lower of 25% of the value of the individual’s benefits and 25% of the LTA. Some individuals have a higher “protected” PCLS entitlement. As a result of the LTA change, from 6 April 2023, the maximum PCLS for those without a protected PCLS will be frozen at £268,275 (being 25% of the current LTA).

Annual allowance

What is happening? The annual allowance (AA) will be increased to £60,000 from 6 April 2023. In addition, the minimum tapered AA will be increased to £10,000 from 6 April 2023. The adjusted income threshold for the tapered AA will also be increased from £240,000 to £260,000 from 6 April 2023. Lastly, the money purchase AA (MPAA) will be increased to £10,000 from 6 April 2023.

What is the AA? As a reminder, the AA is the maximum amount of tax-relieved pension savings that an individual can make in a tax year. It is currently £40,000. The tapered AA applies where an individual has threshold income of £200,000 and adjusted income of £240,000. Threshold income is broadly taxable income while adjusted income is broadly taxable income plus employer and employee pension contributions. Where the tapered AA applies, an individual’s AA is reduced by 50p for every £1 over the adjusted income threshold, down to the minimum level. The minimum level is currently £4,000. The MPAA applies to an individual’s future DC savings where the individual has accessed their previous DC savings. It is currently £4,000. An AA charge is payable when an individual’s pension savings in a tax year exceed the AA/tapered AA/MPAA, as applicable.

Implications for trustees and employers

Trustees – There are a number of steps which trustees should consider taking and they should also liaise with their pension scheme administrators and/or pensions team. For example, they will need to update their administration processes and their member communications to reflect the various changes. Consideration should also be given to whether to issue a member communication on the changes.

Employers – It will be necessary for employers to update employee communications which refer to the LTA, AA, tapered AA or MPAA. Employers should also consider whether they wish to make changes to any arrangements that they have put in place for employees who have ceased or limited benefit accrual to avoid breaching the AA, tapered AA, MPAA or LTA or to avoid losing a form of LTA protection.

Both trustees and employers – In addition, trustees and employers will need to consider whether they wish to make any changes to their scheme rules in light of the changes. For example, scheme rules may provide for benefit accrual to be capped to prevent members exceeding the LTA. Some employers and trustees may wish to remove such provisions to enable members to benefit from the abolition of the LTA. Equally, others may wish to ensure that the abolition of the LTA does not cause those provisions to fall away if this would have a significant impact on the scheme’s liabilities.

Other points to note

The changes will not be retrospective so members will not be able to claim back LTA or AA charges that they have paid previously.

Finally, with a general election not far off, Labour has said that if it comes into power it will reverse the abolition of the LTA, although no details are given.

For more information, or advice in relation to the changes, please speak to your usual Mayer Brown contact.