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Tax-free pension changes: what they mean for you

Chancellor Jeremy Hunt’s sweeping boost to UK pension tax breaks looks set to benefit many higher earners, including doctors, lawyers and bankers.

But this week’s announcements raise as many questions as they give answers. Pensioners and pension savers alike are trying to work out what it means for them. Tax planners have been flooded with queries.

Meanwhile, Labour, the favourite to win the next general election, has already pledged to scrap Hunt’s changes, raising doubts about how long the chancellor’s scheme will survive.

In outline, Hunt has abolished the £1.073mn lifetime allowance (LTA) which capped the amount workers could benefit from in tax advantages on their pension pot. From April 6, the tax-advantaged pots will be unlimited.

He also raised from £40,000 to £60,000 the annual allowance limiting how much savers could add to their pot in any year. And he lifted from £4,000 to £10,000 the so-called money purchase annual allowance, limiting the contributions of people who previously triggered a tax charge accessing their pension pot and later resumed saving into it.

Hunt’s stated intention is to dissuade older, better-paid workers from retiring, especially senior staff in the hard-pressed NHS. However, his critics, led by Labour, accuse him of revising the pensions system to benefit the rich, not least in minimising inheritance taxes.

Certainly, people with accumulated pots of £1mn and more will generally profit from the LTA’s abolition. So will those with much more squirrelled away.

But the annual allowance hike will largely profit the middling rich, people earning £100,000 a year, with the means to use up these allowances, and below £260,000, when the concessions start to taper.

FT Money writers look at the key questions.

How can I make the most of these tax changes?

For most pension savers earning lower and middle incomes, the scrapping of the lifetime allowance won’t make any difference. However, for the estimated 2mn on track to big pension pots, there are substantial savings to be made.

If you were planning imminently to withdraw money from your pension, hold off until April 6 and the new tax year, particularly if you are in a final salary — defined benefit — scheme when the lifetime tax charge is applied immediately on pots above £1.073mn. 

If you were holding back pension contributions, either because you didn’t want to hit the lifetime allowance, or because you risked breaching the annual allowance, you can now pay in much more, with the lifetime allowance gone and the annual allowance increased to £60,000. But if you earn more than £260,000, this will taper to a maximum of £10,000, up from a previous threshold of £4,000.

If you’ve taken money out of your pension — for example to cope with the cost of living crisis — and triggered a tax charge, the amount you can pay if you restart your pension contributions will increase to an annual maximum of £10,000.

Those who have refrained from adding to their pension in past years can carry forward up to three years in a tax year. So, the maximum someone could pay into their pension from April will be £180,000 — saving up to £81,000 of tax.

What can I do now to limit the impact of anything Labour might do?

Assuming the proposals go ahead, if you’re at — or approaching 55 — you’ll probably want to top up your pension as much as possible to make the most of the new allowances. Then, on the eve of next year’s general election, extract a lump sum to ensure you don’t face any future adverse tax changes.

If you’re younger and managing your pension to keep it within the lifetime allowance, the decision is more difficult. While it’s ill advised to base savings decisions on potential future policy, accelerated payments now could make you even more likely to breach any allowances reimposed by Labour and face tax charges.

But as David Hearne, a chartered financial planner at Financial Planning Partners, says: “I think everybody should think very carefully about acting on what an opposition party says, especially when they are reacting to what was a surprise policy announcement, just a day later.”

I’m rich and worry about inheritance tax. What can I do to maximise my IHT benefits, assuming the new pension tax regime stays in place?

The chancellor has created an unlimited inheritance tax shelter by abolishing pension lifetime allowance. But it’s complicated.

Today, if anybody dies before 75, their pension can be passed to their beneficiaries tax-free only if it is within the lifetime allowance limit. From next month, this limit goes.

Those dying above 75 can also pass on funds free of IHT, with no limits. But heirs will face income tax charges on the money received at their marginal rates, up to the maximum 45 per cent.

Where the marginal rate is below the 40 per cent IHT rate, it can be worthwhile. Those with big pots are advised to consult financial planners.

 Nilesh Shah, of Barnett Waddingham, says: “It’s a trade-off between 40 per cent IHT and the recipients’ marginal rate of income tax.”

If maximising IHT benefits is your goal, Tom Selby, head of retirement policy at investment platform AJ Bell, says: “It’s simply a case of contributing as much as you can afford and the rules allow.”

You can invest in a pension from earnings, capped at the annual allowance each tax year. Insurer NFU Mutual calculates that if an individual put the maximum annual allowance of £60,000 into a pension from April 6, and a further £60,000 for each of the next 10 years, they could build a pot of £812,298, assuming 4 per cent growth after charges compounding monthly. This would provide an inheritance tax saving of up to £324,919.

Sean McCann, chartered financial planner at NFU Mutual, predicts: “We will see more people taking money from Isas and other investments which are subject to inheritance tax before accessing their pensions.”

However, maximising pension contributions might be difficult if your income (including investment income) is very high, due to the tapered annual cap on contributions, starting on incomes of £260,000.

There may be downsides too. Matt Conradi, head of client advisory at Netwealth, warns: “If you have some form of historical LTA protection, it is not yet clear whether adding funds would void that level of protected tax-free cash.”

Instead, you could look at other tax-efficient investments such as certain Alternative Investment Market shares that qualify for Business Property Relief. Or reduce your IHT liabilities by setting up trusts or giving money away, subject to the seven-year rule, under which the tax charges taper on gifts before death.

What happens to LTA protections? Will they now become irrelevant?

No. The Treasury has confirmed that all existing protections can be maintained if the conditions on which they were granted are followed. As successive governments over time reduced the level at which LTA tax charges were applied, they granted so-called protections to existing savers at the previous higher level, as long as those savers stopped adding to their pots.

Existing LTA-based protection remains valid in the crucial area of accessing the tax-free lump sum, which many savers take out at the start of retirement. For most savers this is 25 per cent of the current £1.073mn LTA but for mainly older people it runs as high as £1.8mn.

Hunt has now scrapped LTA tax charge from April 6, but the 25 per cent cash rule is frozen indefinitely. Labour has not spelt out what it would do.

I am still working, but stopped contributing to my pension because I hit the LTA. Should I restart payments?

Generally, yes. If you secured protection at HM Revenue & Customs on a lifetime allowance, you can now break the LTA limits with your contributions without a penalty.

If you just stopped paying in without any protections, you could restart contributions, also without penalty. Self-employed savers could use a self-invested personal pension (Sipp), but employees should ask to rejoin the workplace pension scheme to take advantage of employer contributions.

After a career break, workplace pension options may be limited. Steve Webb, partner at Lane Clark & Peacock, explains that public sector workers can restart defined benefit (DB) schemes. But in the private sector, many DB schemes have closed to new accruals, so you may have to join the defined contribution offering, he says. The employer contribution would still mean this is better than taking out a personal pension.

Consider Isa contributions too, says Megan Jenkins, partner at Saltus, an asset manager. “Pension rules could change again.” 

I’m retired with a £2mn pension and have other assets. Should I sell them and put the proceeds into a pension pot?

Unfortunately, the new £60,000 annual allowance may not be available to you if you no longer have earned income. Jenkins says: “Once you no longer have pensionable earnings, the amount you can put into a pension is restricted to £3,600 gross a year.”

The situation may be better if you have income-producing assets. Netwealth’s Conradi says that if you have earnings that qualify for tax relief, such as holiday let profits, you could make contributions using the annual allowances. “However, things like dividends and interest don’t qualify,” he says.

But don’t rush to sell assets. Selby at AJ Bell warns the tax liability on selling assets “needs to be considered”. Also, having diverse assets can protect against market volatility.

As an NHS employee, how am I affected by this week’s changes?

The NHS pension scheme has been made more flexible to encourage people to work longer.

More personal finance Budget coverage

The scheme is made up of three parts, broadly declining in generosity — the 1995 section, the 2008 section and the 2015 section — with many staff building up entitlements in different sections.

Until now, a retired member of the 1995 scheme returning to work had to do so on a non-pensionable basis. From now, members of the 1995 scheme who want to return to work after retirement can take their accrued pension benefits in full, then join the 2015 scheme and build more retirement savings.

Many NHS employees in the 1995 scheme stopped working at 60 because delaying retirement beyond that age would not bring a higher pension. Now it will. “This will remove a key disincentive to work beyond age 60 for 1995 scheme members,” says Claire Trott, divisional director of retirement planning at St James’s Place, the wealth manager.

I am a buy-to-let investor. Should I sell property and put funds into my pension?

Landlord investors, hit in recent years by regulatory and tax changes including the loss of relief on mortgage interest, are now confronting steep rises in interest rates on mortgages. Not surprisingly, some are selling up.

For those owning property personally and considering a sale, the removal of the LTA “definitely could be seen as offering an alternative,” says Graeme Bone, a financial planner with Beaufort Financial (Pathfinder). 

But for landlords who own via a company structure — the great majority of full-time landlords with large portfolios — their business is more likely to remain viable and can already be passed to heirs through shareholdings.

For both types, the attractions of pension saving must be weighed against the costs of selling up, since selling may well trigger a capital gains bill.

Another worry is whether Hunt’s abolition of the LTA stands the test of time. Neal Hudson, founder of Residential Analysts, says: “It’s clearly going to be a political target in future.” 

Reporting by Mary McDougall, Moira O’Neill, Chris Flood, James Pickford, and Stefan Wagstyl

What it means for you — case studies

The maxed-out LTA-er

An executive in their fifties, paid £150,000-a-year, stopped saving into their pension pot because they hit the lifetime allowance limit and have a protected £1.073mn pot. Should they resume contributions?

There is an opportunity, by the end of the 2022-23 tax year, to include a £40,000 pension contribution for the 2019-20 tax year. And to add up to £160,000, in annual allowances for the four years to April 5 2023.

The employee contribution cannot exceed 100 per cent of taxable earnings. Extra might need to come from the employer, if it agrees. The executive can now contribute £60,000 a year in future, up from £40,000. Pension contributions may reduce taxable earnings below £100,000 — so the executive gets back their income tax personal allowance.

However, the eventual tax gain may be down to any difference between the current marginal rate and the rate when the person retires.

Simply, the executive could save £22,460 in tax based on tax saved of £52,460 on contributions of £150,000 versus future tax of £30,000 on drawing £150,000 from the pot. That assumes the basic 20 per cent income tax is charged, and ignores investment returns and inflation. In the simplified example, if all £150,000 is taxed, when drawn at 40 per cent, future tax would be £60,000, an additional £7,540 rather than a saving.

The regular LTA-er

A manager in their forties with a £100,000 salary has paid the maximum annual allowance (AA) into a pension. How much can they save now that allowance has risen?

As the manager has contributed the maximum each year, there will be no unused AA to carry forward. Assuming his total taxable income from all sources, plus pension contributions, do not exceed £260,000, AA would not be tapered. In this case he could contribute up to £60,000 in 2023-24 without an AA tax charge.

If they had not fully utilised the AA in the previous three years, in 2023-24 they could contribute up to £60,000 plus the total unused AA from the previous three years. The tax relief would be limited to taxable income for the tax year. Some contributions may not receive any tax relief and some will receive tax relief at the lower 20 per cent marginal rate tax band. The estimated initial tax saving on a £100,000 contribution is £27,400, although future retirement income drawdown would be subject to tax.

The £2mn-plus pot

A recent retiree has a £2.073mn pension pot. What should they do?

It is assumed that before April 6 2023 the individual has crystallised only £1.073mn of the pension, taking £268,275 of this as a tax-free cash sum. The remainder of the pot is left invested as an uncrystallised fund.

There will be no LTA charge from April 6, so any drawdown by the individual from either the crystallised or uncrystallised fund would be subject to income tax at the individual’s marginal rate of tax. The tax saving would be on the uncrystallised pot.

Previously, the LTA tax would have been 55 per cent if the uncrystallised fund was taken as a lump sum. From April 6 almost all will be taxable at the 45 per cent marginal rate if taken as a single lump sum. The tax saving on the uncrystallised fund of £1mn will be £100,000 (10 per cent of £1mn) if taken as a single lump sum.

If the retiree wanted to use the pension fund as inheritance rather than retirement funding, and if they die after April 6 2025, distribution to beneficiaries would be taxable at their marginal income tax rate. In this case, the tax saving could be potentially greater than 10 percentage points — difference between 55 per cent LTA tax charge and recipients’ marginal rate of income tax). If the recipient took a large single lump sum, most would be taxable at 45 per cent.

The IHT planner

A wealthy banker wants to use the pension pot as an IHT break. How should they maximise future IHT gains? Should they contribute more than £60,000 a year putting in taxed income, for the sake of IHT gains?

At present, the IHT rate is 40 per cent. In the event of death after April 6 2025 when the LTA is fully abolished, although the pension pot may not be subject to IHT, the payments to beneficiaries would be taxable at their marginal income tax rate. So it’s a question of the difference between IHT at 40 per cent and the recipients’ marginal income tax rate. If the marginal rate is less than 40 per cent, it may be beneficial to put taxed income into the pension pot.

If the contributions are made while the member is in good health there will, in tax terms, be no transfer of value. But if the member is ill, there may be a transfer of value and the IHT exemption may be lost.

Source: Nilesh Shah, Barnett Waddingham

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