Background
The removal of the life time allowance (LTA) has lifted a huge barrier to pension saving and provides an opportunity for those individuals who were previously close to, or over, the LTA to now revisit their retirement funding plans. Where an individual may have stopped funding as a condition of enhanced or fixed protection, or simply because they wanted to stay below the LTA to avoid any future LTA charges, the removal of the LTA means they can resume funding with impunity.
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.
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 open the opportunity for some to now join their employer’s auto-enrolment scheme, which previously they may have had to decline in order to retain their LTA protection.
Detail
The Changes
- The annual allowance has increased from £40,000 to £60,000 with effect from 6 April 2023. This could mean an additional £8,000 tax relief for higher rate taxpayers, increasing to £9,000 for additional rate taxpayers. 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 individuals with income of £360,000 or more.
- 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.
The Opportunity – How Much?
- High net worth individuals with either enhanced or fixed protection will have stopped making contributions many years ago. This year will be the first opportunity for those individuals to bolster their pension savings. Since it is possible to carry forward any unused annual allowances from the last three tax years (maximum of £40,000 per year) plus the higher allowance of £60,000 for 2023/24, means that up to £180,000 could be paid in (assuming no tapering).
- 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.
- For business owners, as the main rate of corporation tax has increased from 19% to 25% from 1 April 2023, paying additional employer pension contributions can provide an attractive method of extracting profits tax free, alongside the national insurance (NI) savings opportunities.
Why Save into a Pension?
When saving for retirement a pension will, in most cases, provide higher net returns than an ISA purely based on the tax mechanics. Whilst both enjoy tax free growths, 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.
Other benefits from saving into a pension include:
- Pensions are generally free of inheritance tax, 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.
If you would like more information on the recent changes to the lifetime allowance and pensions in general please contact Mark Underwood at Muras Baker Jones Financial Services Limited.
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