The chancellor announced some significant changes to the tax rules for UK registered pension schemes. I am going to explain how I think those changes will impact individuals.

Why change the annual allowance and lifetime allowance?

This is a slight deviation, but I would like to share my experience of a recent visit to a grumpy consultant cardiologist. Thankfully, my heart was in great shape, but I made the mistake of mentioning my profession in pension scheme taxation and spent the next hour discussing the cardiologist’s defined benefit pension fund and the impact of the lifetime allowance. He charged me for the full hour by the way.

This cardiologist and his peers have been giving the government a real headache because they desperately need his generation to stay in work, do extra shifts and get those NHS waiting times down. The problem is that defined benefit pension schemes are based on the doctor’s pensionable salary. This means an increase in pensionable salary, perhaps through extra work, can quickly result in the annual allowance being exceeded. Generous defined benefit pensions also quickly use up the annual and lifetime allowance. Most doctors could opt for ‘scheme pays’ whereby an annual allowance charge is met by the pension scheme with the cost knocked off the value of the pension scheme benefits. Regardless, many doctors felt they were being penalised by the tax system for working more and increasing their pay.

The chancellor decided to solve this and went big. He increased the annual allowance from £40,000 to £60,000 with a higher threshold (£260,000) at which earners start to taper that annual allowance down to a minimum of £10,000 (previously £4,000). He also chucked in an abolition of the lifetime allowance presumably, so doctors were not discouraged from accruing pension pots over the limit of £1.073m.

Changes for UK registered pension schemes from 6 April 2023

The Finance (No.2) Bill 2022/23 has just passed Committee stage with nine amendments passed, none of which impact the parts regarding these pension reforms. There may be some technical amendments in the Public Bill Committee scheduled in May 2023. The following summarises what this Finance Bill will change from 6 April 2023:

• The annual allowance for UK registered pension schemes increased. The annual allowance restricts the amount of tax relieved pension contributions an individual can make in a tax year. Contributions exceeding this limit have tax relief reversed by way of an annual allowance charge levied at the taxpayer’s marginal tax rate. This annual allowance increased from £40,000 to £60,000 p.a. This means that an additional rate taxpayer could now save up to £27,000 (£28,200 in Scotland) in income tax a year. Higher pension scheme saving can also result in class 1 NIC savings for employees on salary sacrifice arrangements.
• Certain higher earners have the standard annual allowance reduced if their ‘adjusted income’ exceeds a threshold. This annual allowance tapering remains, but from 6 April 2023 the ‘adjusted income’ threshold increases from £240,000 to £260,000. The minimum annual allowance (the ‘money purchase annual allowance’) now bottoms out at £10,000 (previously £4,000).
• The lifetime allowance is abolished. Savings in UK registered pension schemes that exceeded this limit attracted a lifetime allowance charge of either 25% or 55%, depending on how benefits were taken. Simply put, lump sums above 25% of the lifetime allowance were hit with the 55% charge; if, though, the excess was taken as a pension, annuity or via drawdown, the charge was 25%. From 6 April 2023, no lifetime allowance charges will be paid.
• If an individual takes a ‘pension commencement lump sum’, it is tax free. The maximum pension commencement lump sum used to be 25% of the lifetime allowance. From 6 April 2023, the pension commencement lump sum cannot exceed £268,275 (25% of the old lifetime allowance). For those who obtained protection in respect of an old lifetime allowance (for example, fixed protection 2016, enhanced protection, etc), the tax free sum is based on those old protected limits.
• There are some reductions to certain death benefit charges from 55% to 45%.

What would a future Labour government do?

At the time of writing, the bookies are offering odds of 2/9 that the Labour party will form a majority government at the next election. We therefore need to think about what a new government would do with registered pension schemes and Labour has been very clear, saying: ‘At a time when families across the country face rising bills, higher costs and frozen wages, this gilded giveaway is the wrong priority, at the wrong time, for the wrong people.’ It will reinstate the lifetime allowance.

I make no comment on this policy other than to state that this has implications for individuals who are 55 and considering when to draw their pension benefits. Many will be well advised to do it while no lifetime allowance exists.

How should tax advisers advise their clients?

This is an area where tax advisers need to be especially careful that they do not inadvertently stray into the realm of regulated investment advice unless properly regulated. So, viewing this purely from a tax perspective, what should advisers consider?

Should individuals crystalise their pension pot before the rules change again?

The old lifetime allowance worked by taking a snapshot of all UK registered pension scheme savings when the taxpayer ‘crystalised’ a pension plan. It is a common misconception that an individual needs to take out all their pension benefits in order to trigger the lifetime allowance test. In fact, it is not necessary to have all benefits paid out and there are several (13) benefit crystallisation events. Some common ones include:

• taking a pension commencement lump sum (the 25% tax free lump sum taken when a member first accesses their pension) and enters into a drawdown fund;
• the pension scheme buying an annuity;
• starting to receive a scheme pension (for example, starting a final salary pension); and
• transferring to a qualifying overseas retirement benefit scheme.

A taxpayer who is 55 years old or older will be able to draw benefits and crystalise their UK registered pension scheme. If their pension savings exceed the old lifetime allowance limit (£1.073m), they should consider doing this in the next couple of years before a government is elected. There is risk in accelerating pension withdrawal plans when we do not know the makeup of a future government or how they would legislate to reintroduce it. All that considered, this author knows of several clients who will choose to accelerate their pension distribution plans in order to do so before the current rules change again, potentially for the worse.

Should individuals save into UK registered pension schemes to manage inheritance tax?

A UK registered pension scheme is exempt from an inheritance tax charge during life (lifetime transfers into trust), on death and the ten-year charge for discretionary trusts does not apply. If any pension benefits are not taken, then on death these do not form part of the death estate and are passed to beneficiaries free of inheritance tax. If the individual is over 75 years old at death, the beneficiaries may pay income tax at their marginal rate; this is, though, often less than the inheritance charge that would have applied. There are some potential traps here. There must be an expression of wishes in place (so the trustee has discretion over who to pay benefits) and the individual must not be in poor health when they save into the scheme.

I have seen advisers advocate strongly for pension scheme saving for this purpose. Now that there is no lifetime allowance charge, the total savings can be unlimited. The pension plan could even be funded with contributions that exceed the annual allowance, providing that the individual is happy to accept no income tax relief on the amounts contributed. Is this a good idea? In my view, it is not.

Assuming contributions are not made in poor health (see my comments above), death can be a very long way away. This means the individual must expect that the inheritance tax rules and the rules for UK registered schemes generally continue unchanged into the future. Given the amount of change made to pension plans in my professional lifetime that seems like a hazardous bet. The government may also feel justified in making changes if inheritance tax avoidance using UK registered pension schemes becomes commonplace.

Should individuals save more or restart pension contributions?

The Budget changes mainly impact those near retirement with substantial savings. The younger workforce is unlikely to notice much difference.

Some employees will have opted out of their employer’s pension arrangements in exchange for higher salary in order to prevent annual allowance charges or lifetime allowance charges or to prevent the loss of previous lifetime allowance protections. In light of the new rules, those employees should consider whether they should opt back in.

That said, any individual with a lifetime allowance protection should check to see what impact further contributions have and the implications of a loss of that protection. Even though the lifetime allowance has been abolished, the 25% tax free lump sum is calculated on the old £1.073m limit unless the individual has a higher fixed lifetime allowance. For example, an individual with ‘fixed protection 2014’ will be entitled to a tax-free lump sum calculated on 25% on the £1.5m lifetime allowance that was protected. That would mean they have a tax-free lump sum of £375,000 compared to the new fixed 25% tax free lump sum of £268,750.

If an individual has already crystallised their pension plan, they could consider restarting pension scheme contributions given that the new money purchase annual allowance is now £10,000 p.a.

Is there an impact on non-UK schemes?

Yes. Some non-UK, unregistered pension schemes will have received UK tax relief on employee and/or employer contributions. These pension plans will either:

• have obtained tax relief through a double taxation agreement (for example, a US employee resident in the UK and saving into a US 401(k));
• have met the conditions of ‘migrant member relief’;
• be an overseas pension scheme that is exempt from a benefit in kind charge under ITEPA 2003 s 307 (and ITEPA 2003 Part 7A); or
• be some legacy arrangements that benefitted from ‘transitional corresponding relief’.

The impact is that these plans are subject to most of the same rules as a UK registered pension scheme including the annual allowance and lifetime allowance. They may also benefit from inheritance tax exemptions. Many of these individuals will no longer be tax resident in the UK and will be relying on double taxation agreements to protect their tax relieved pension savings from UK income tax. It is worth noting that the lifetime allowance charge was a penalty charge, not income tax, meaning that all treaties failed to give protection to non-resident taxpayers for lifetime allowance charges. These individuals might also consider bringing forward benefit crystallisation.

Good news, right?

The changes could significantly reduce pension tax bills for those about to retire. But if we take a longer view, we might reflect on the significant reforms made in April 2006 (‘A-day’) to UK registered pension schemes. The idea was to simplify a system that was becoming increasingly complicated. Since then, the lifetime allowance has changed many times (does anyone remember the ‘special annual allowance charge’ penalising lump sum contributions?), and annual allowance tapering, lifetime allowance reductions and the corresponding lifetime allowance protections were introduced. Compare that mess to US 401(k) plans, the US equivalent of the UK registered scheme, where the rules have remained basically the same over that period.

It’s worth remembering that the psychology of pension scheme investing is different to that of normal investing. Once contributions are made, you must say goodbye to them until you are 55 years old, with no opportunity to withdraw and invest elsewhere. Given that there is such an established Treasury practice of adjusting UK pension scheme rules, it is very hard to know how your pension scheme benefits might be taxed on retirement.

Where does this leave us?

For individuals close to or exceeding the old lifetime allowance:

• The abolition of the lifetime allowance will save these individuals tax. They should consider the timing of retirement and the impact of crystallising funds now before changes are made to this benign regime.
• Individuals may also be able to restart pension contributions but should check the impact of this on any lifetime allowance protections.

For everyone else:

• Saving into a UK registered pension scheme saves income tax (also possibly NICs) and is particularly effective if you are a higher earner. The new rules mean most people can save more.
• The increase in the money purchase annual allowance to £10,000 means that some employees will be able to rejoin their employer’s pension scheme.
• Individuals should be cautious about saving into a pension scheme for the purposes of succession planning, as the goalposts may move in the future.