Techzone

The abolition of the lifetime allowance (LTA) has removed a huge barrier to pension saving and creates a fantastic opportunity to revisit clients' retirement funding plans.

Clients who have stopped funding as a condition of enhanced or fixed protection, or simply because they want to stay below the LTA to avoid any future LTA charges, can resume funding with impunity. Paired with an increase in the annual allowance, the incentives to maximise pension savings are compelling.

While there will be no LTA charges levied from the 2023/24 tax year, LTA protections may still be important to retain rights to higher levels of tax free cash. They may also reduce tax charges on certain lump sum death benefit payments.

Any new pension funding will not cause these protections to be lost provided the protection was registered by 15 March 2023 and not lost by 5 April 2023. It may also mean for some that they will be free to join their employer's auto-enrolment scheme, which previously they had to decline to retain their LTA protection.

The changes

While an increase in the LTA was expected before the Budget, the decision to abolish the charge altogether was left-field. This is a welcomed change and will simplify the choice of where to save as net returns will no longer be diminished by an LTA charge.

The annual allowance has increased from £40,000 to £60,000, could mean an extra £8,000 tax relief for higher rate taxpayers, increasing to £9,000 for additional rate taxpayers. Tax relief could be enhanced further if it facilitates the reinstatement of some, or all, of the personal allowance.

The new annual allowance will not be tapered until income exceeds the 'adjusted income' threshold of £260,000. The minimum tapered annual allowance also moves up to £10,000 (from £4,000 in 2022/23) and will only apply to clients with income of £360,000 or more.

This represents a significant increase in the amount of allowance available to certain clients. For example, someone with income of £312,000 last year was only entitled to the minimum allowance of £4,000. This year they could pay up to £34,000 for the same level of income.

And those who are subject to the new minimum tapered annual allowance will still receive tax relief of £4,500 - an increase of £2,700 on last year.

The money purchase annual allowance (MPAA) also goes up from £4,000 to £10,000. This may be good news for those who have started to draw down income from their pension pot but continue to work in some capacity, as it may reduce or eliminate any tax penalty incurred as a result of being a member of their employer's auto-enrolment scheme.

The opportunity – how much?

High net worth clients with either enhanced or fixed protection will have stopped making contributions many years ago. This year will be the first opportunity they have to bolster their pension savings. As they can carry forward the unused annual allowances from the last three tax years (£40k per year) plus the higher allowance of £60,000 for this year, means that up to £180,000 could be paid in (assuming no tapering). However, tax relief at the highest rates may only be achieved by spreading the unused allowance over more than one tax year.

The same opportunity arises to those who had simply decided to stop contributions because they were concerned that the value of their savings may exceed the LTA.

With the additional rate tax threshold dropping to £125,140 this year, the option of making larger payments may be particularly attractive to those who would otherwise be paying tax at 45% for the first time.

In addition to tax relief, such large contributions may also reduce threshold income to below the £200,000 limit so that the annual allowance is not tapered. Similarly, reducing adjusted net income (ANI) to below £125,140 will restore some or all of the personal allowance (personal allowance is fully restored if ANI is less than £100k). Both indirectly increase the effective rate of tax relief for saving into a pension.

Business owners

The main rate of corporation tax is 25% for the current tax year, up from 19% last year. Alongside the NI savings, the higher rate of relief on employer contribution will be more attractive to directors as a means of taking profits from their business. Provided they are not part of any contractual sacrifice arrangements, such payments don't count towards threshold income, though would increase adjusted income.

Another change for this year which may facilitate a higher tax efficient contribution from self-employed clients are the new basis period rules under which they are assessed to income tax. In a nutshell, the transitional provisions for 2023/24 could increase taxable profits, and therefore relevant UK earnings. This is as a result of aligning self-employed profits to the tax year from April 2024 and any spike in profits this year may be spread over the next five tax years.

Why save into a pension?

When saving for retirement, a pension will in most cases provide better net returns than an ISA, purely based on the tax mechanics. Both enjoy tax free growth, but ignoring this, the pension outcomes will depend on three factors – tax relief on the way in, the tax rate on income withdrawn, and the availability of tax free cash.

While certain individuals can now resume funding their pensions without the concerns of losing protection or incurring an LTA charge, new savings may not attract any further tax free cash. Despite this, a pension will still be a favourable option provided tax rate when benefits are taken is not greater than the rate of tax relief received when contribution are made.

The table looks at a sample of pension returns on a gross contribution of £1,000 where the rate of tax relief on payments in is greater or equal to the income tax on withdrawals, and with and without tax free cash:

This confirms that where tax free cash is available, there is a positive return even where the tax rate on withdrawal equals the rate of tax relief given on contributions.

The same is true even where no tax free cash is available if the tax rate on withdrawal is less than the rate of tax relief given.

Where the tax rate on withdrawal is the same as the rate of tax relief on the contribution and there is no tax free cash available, we get a neutral outcome. This scenario mirrors the returns from an ISA. But there are still arguments in favour of a pension being the preferred choice for retirement savings:

• Pensions are generally IHT free, and therefore more attractive when transferring wealth to the family.
• Pension savings can be passed on via inherited drawdown, which means that chosen beneficiaries can continue to hold their inheritance in a tax favoured wrapper. Only a spouse or civil partner can 'inherit' an ISA.
• Where pension savings are inherited on death after reaching age 75, they will be taxed at the beneficiary's marginal rate of income tax, which may be lower than the member's own tax rate. If the member dies before age 75, there may be no income tax at all.

The future

Concerns have been raised over what a Labour Government might do if elected at the next General Election. Could they re-introduce the LTA in some form? Alastair Black, abrdn Head of Savings Policy, commented in a recent article 'Why the Chancellor's lifetime allowance surprise can give confidence to pension savers' which covers what this could mean. The situation can be summarised as follows:

'No-one can say that won't happen, but advisers should consider:

• advisers can only advise on the rules as they currently stand. Advice cannot be based on a presumption of what might change in the future as it could end up being the wrong advice if the predicted changes do not happen
• no UK political party is likely to want to introduce unnecessary complexity into the pension system. We can expect future governments to change pension policy, but they are likely to look at the system holistically to determine the outcomes they want
• historically, successive UK governments have not applied retrospective change to pension policy penalising actions to date. That's been true of all political parties that have been in power.'