A surprise announcement in the Budget to abolish the lifetime allowance for pensions also gave some respite to users of pension drawdown and the annual allowance.
A number of significant changes to pension tax were announced by the Chancellor Jeremy Hunt in the spring Budget, which will affect pension savers and will be welcome news for higher income taxpayers.
The annual allowance is one of three controls on tax relief for pension savings, the others being the annual earnings limit and the lifetime allowance. With effect from 2024–25, the lifetime allowance is to be abolished.
The annual allowance limits the amount of tax-relievable inputs an individual may make in any one tax year to one or more registered pension schemes of which the individual is a member.
When the annual allowance is exceeded (technically, when an individual who is a member of one or more registered pension schemes has a non-zero ‘chargeable amount’), a charge to income tax, known as the annual allowance charge, arises.
A non-zero chargeable amount exists, broadly, when the individual has a ‘total pension-input amount’ that exceeds the individual’s annual allowance for that year (Finance Act 2004, s227(1), 227ZA ). This is known as the ‘default chargeable amount’.
The charge also applies, with modification, in the case of certain non-UK pension schemes.
The amount of the annual allowance for the year 2023–24 has been increased to £60,000 from £40,000.
However, in the case of a high-income individual, the annual allowance is tapered down so it does not fall below a minimum of £10,000 (previously, £4,000).
A high-income individual is an individual whose ‘adjusted income’ for the tax year is more than £260,000 (previously £240,000) and whose ‘threshold income’ for that year is £260,000 minus the annual allowance (in 2023–24, therefore, £200,000, as previously).
For tax years in which or after which the individual first takes advantage of flexible access to benefits, a non-zero chargeable amount (the alternative chargeable amount) may arise if the individual’s money-purchase input sub-total exceeds what is effectively a money-purchase annual allowance (MPAA), which in 2023–24 is £10,000 (previously £4,000).
Money purchase input sub-total
An individual’s money-purchase input sub-total is the total of:
• the pension input amounts for each money purchase arrangement the individual has under a registered pension scheme of which the individual is a member; and
• the pension-input amounts for each hybrid arrangement the individual has under a registered pension scheme of which the individual is a member and which offers money purchase benefits.
Pension inputs into a money purchase arrangement, other than a cash balance arrangement, are simply the total of relievable pension contributions made by or on behalf of the individual and employer contributions in respect of the individual.
If the individual has no hybrid arrangements, therefore, the money purchase input sub-total will simply be the sum of employee and employer contributions to the scheme.
The alternative chargeable amount
For 2023–24, the alternative chargeable amount is the total of:
• the amount by which the money purchase input sub-total exceeds £10,000; and
• the amount (if any) by which the defined benefit input sub-total exceeds £50,000.
The defined benefit input sub-total is the total of:
• the pension input amounts in respect of each defined benefits arrangement the individual has under a registered pension scheme of which the individual is a member; and
• the pension input amounts in respect of each hybrid arrangement the individual has under a registered pension scheme of which the individual is a member and which offers defined benefits.
Calculation of the pension input amount for a defined benefits arrangement is quite complicated, but, very broadly, it is the difference between the opening and closing values of the expression
(16 × expected pension) + lump sum (LS),
where LS is the expected lump sum (if any) the individual may take otherwise than by commuting the pension.
When does alternative chargeable amount apply?
The alternative chargeable amount, including the MPAA, applies only where it would exceed the ‘default chargeable amount’.
Thus, if the excess of all the individual’s pension input amounts over £60,000 is greater than the alternative chargeable amount, the default chargeable amount applies.
Tapering the annual allowance
As we have seen, an individual member of a registered pension scheme who has an ‘adjusted income’ for the tax year greater than £260,000 and a ‘threshold income’ greater than £200,000 faces a reduced annual allowance. Such an individual is referred to as a ‘high income individual’.
Broadly speaking, ‘adjusted income’ is an individual’s net income after all reliefs except those for pension contributions, and it also includes employer pension contributions. An individual’s threshold income for the tax year is their net income after all pension contributions have been deducted, unless salary sacrifice or flexible arrangements are in place.
Where an individual is a ‘high income individual’, meeting the conditions described above, the annual allowance is tapered down by reducing it for the year by £1 for every £2 by which the individual’s adjusted income exceeds £260,000.
The amount of the reduction is rounded down to the nearest £1, but may not be less than £10,000.
Artificial manipulation of adjusted or threshold income
There is an anti-avoidance rule to counter avoidance schemes that are intended to prevent any reduction in the annual allowance or to reduce the amount by which it is reduced for high income individuals. Its effect is, quite simply, to restore the reduction to the allowance that would have been made if the arrangements had not existed.
The anti-avoidance rule applies to arrangements where each of three conditions, A to C, is satisfied.
Condition A
Condition A is that it is reasonable to assume that the main purpose or one of the main purposes of the arrangements is to reduce the reduction required by the taper for the tax year or for two or more tax years that include the tax year.
Condition B
Condition B is that the arrangements involve reducing the individual’s adjusted income or threshold income for the tax year.
Condition C
Condition C is that the arrangements involve redressing that reduction by means of an increase in adjusted net income or threshold income for a different tax year.
Carry-forward of the annual allowance
Where the annual allowance for a tax year exceeds the pension input amount for that year, a limited form of carry-forward is available.
Where, in a tax year (the ‘current year’), an individual has ‘unused annual allowance’ available, the individual’s annual allowance for that year will be increased by the amount of that unused annual allowance.
An individual has ‘unused annual allowance’ where:
• in the immediately preceding tax year (Year −1), the individual’s annual allowance (ignoring any amounts brought forward under these rules) was greater than the individual’s total pension input amount; and/or
• in the two years immediately preceding Year −1 (Years −2 and −3) the individual’s annual allowance for one or both of those years (ignoring any amounts brought forward under these rules) exceeded the individual’s total pension input amount for either or both of those years and that excess or those excesses are not ‘used up’ (ie, already applied under these rules to increase the annual allowance in a following year).
An amount of annual allowance is ‘unused’ to the extent that, ignoring the effect of any carry-forward, it exceeds the pension input amount for that year and, where that excess arises in Year −2 or Year −3, that excess has not been ‘used up’.
An excess is ‘used up’ if there is an excess of pension input amount for an ‘intervening year’ (ie, one between the year in which the excess arose and the current year) and that excess has been used under these provisions to reduce an annual allowance charge for that intervening year.
In any year, unused annual allowance brought forward is used up on a ‘first-in, first-out basis’, ie, the allowance for earlier years is used in priority to that for later years.
Lifetime allowance
The lifetime allowance charge will be removed from April 2023 before the allowance is abolished entirely from April 2024.
The current limit is £1,073,100, which caps the total amount of tax-free savings which can be held in an individual’s various pensions.
These reforms are designed to ensure that highly skilled individuals such as NHS clinicians are not disincentivised from remaining in the workforce by reducing the risk of incurring significant pension tax charges.
This measure will cost the Treasury £2.75bn over the next five years until 2028.
The lifetime allowance, the maximum amount you can hold within a pension during your lifetime, was introduced in 2006 and at the time the limit was nearly £2m but this has been reduced by successive Chancellors.
Under the current rules, exceeding the standard lifetime allowance of £1,073,100 will lead to additional tax charges on the excess when you come to take your pension benefits or turn 75.
Now that the limit on the lifetime allowance is being removed, high earners will have the opportunity to save unlimited funds in pensions. In future, pensions could also be used for effective inheritance tax planning as under current rules, most pension pots are inherited free of inheritance tax, and are taxed at the individual’s effective tax rate.
Most pensions are set up under a discretionary trust and the pension holder must name the beneficiaries of their pensions for this to work. It is not clear whether the government will introduce some anti-avoidance rules to address this issue. This will be clearer once the full legislation is available later this year.
Conclusion
The 50% increase in the annual allowance announced by the Chancellor, together with the increase in the money purchase annual allowance to £10,000 has undoubtedly opened the way to increased pension savings for those with the means of making pension contributions of this order, and must be seen in the light of the concomitant abolition of the lifetime allowance charge.
For the highest earners the removal of the lifetime allowance will be a welcome move, but will benefit under 10,000 high income individuals a year.
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