Make pension contributions while the sun shines!
17th March 2023
Posted in Articles, Budget by Andrew Marr
The issue
Yesterday, Jeremy Hunt made the shock announcement that the pension scheme lifetime allowance ‘LTA’, which had been £1,073,100 will be abolished from 6 April 2023, effectively meaning that pensions can grow up to an unlimited value without incurring punitive tax charges. The only slight catch is that the 25% tax-free lump sum that can be taken will continue to be limited to £268,275 or 25% of the 2022/2023 LTA (above).
The relevance of the LTA is that at various ‘benefit crystallisation events’ the value of the scheme is tested and if it exceeds the LTA then there will be a punitive tax charge. Such events include (among other things) when payments are made out of the scheme and also when the pension beneficiary reaches the age of 75. This works by recording the percentage value of the scheme when these events occur and returning tax if the cumulative percentage ends up exceeding 100%.
Example
John was 65 in August 2012, when the LTA was £1.5m. His SIPP was worth £1.2m. He decided to take his 25% tax-free lump sum of £300,000 and designate the remaining £900,000 into drawdown. Here he has used 80% of his LTA and so will have to test future benefit crystallisation events against 20% of the LTA.
In August 2022, John reaches his 75th birthday when his drawdown pot is worth £1,330,000. This increase of £430,000 is worth 40.07% of the LTA of £1,073,100. As he only has 20% of the LTA left, then there will be a charge on 20.07% of the LTA, or £215,049. This charge would be at 25% (£53,762) and would be paid out of the pension.
The prospect of such LTA charges has put many people off making further contributions. Currently tax-free contributions of potentially up to £160,000 can be made in 2022/2023, based on £40,000 for the current year and up to £40,000 in respect of unused allowances for each of the three previous years. From 2023/2024 that annual allowance will increase from £40,000 to £60,000. Even those high earners who were tapered to a £4,000 maximum contribution will be able to contribute £10,000 and so potentially more can be paid into the pension pots. Many people will now want to resume making contributions, given that the prospect of future punitive tax charges has been lifted.
U-turn from Labour?
Labour have said that if they get in then they will reverse this measure which they say favours the richest 1% in the country. This means that individuals who are close to having funds of £1,073,100 should ‘make contributions while the sun shines’. If Labour were to change the rules, then we would expect that protection would be offered for any funds that stand at a value in excess of the LTA that has been put in place. This has been the case every time the LTA has been reduced in the past and is in line with the general rule that retrospective taxation should be avoided.
Forbes Dawson view
This is a very welcome change in rules. In particular, this means that pensions can now be used more effectively to keep funds outside of the estate for inheritance tax purposes. Previously, the prospect of a large tax charge at the age of 75 was a deterrent to this kind of planning. Of course, there are still restrictions on what can be contributed (above). As an aside, there must be some twins out there who were born a few minutes before midnight on 5 April 1948 and a few minutes after midnight. If they both had £2m (say) in pension schemes, then one could be hit with a tax charge of up to £231,725, whereas the other would have no charge at all (the LTA only falls away from 6 April 2023). Hopefully that individual would have taken 2006 protection, but that is another subject…
