Chancellor Jeremy Hunt went further than expected with major changes to pension savings in his budget today.
The biggest step came when Hunt abolished the restrictive pension lifetime allowance entirely, rather than increasing it from just under £1.1m to £1.8m, as expected.
It also raised the annual allowance on contributions that can be made from £40,000 to £60,000.
The Chancellor also increased the amount that workers who have already withdrawn from their pension can pay into their pension funds each year without tax penalty, from £4,000 to £10,000. This is known as the Annual Money Purchase Allowance.
The measures are most likely to help high-income earners who have already amassed significant pension funds, and are aimed at keeping professionals over 50, such as doctors, on the job.
But what difference will the annual and lifetime allowance shakeup make? Will they ever help him? We explain the changes in pensions that the Chancellor has made and what it means for you.
Pension reorganization: Chancellor Jeremy Hunt has made three big changes to the way Britons can access their pension and how much they can save and still get tax benefits
What are the changes in budget pensions in a nutshell?
Chancellor Jeremy Hunt gave a boost to high-income workers by removing limits on how much you can save in a pension, known as an annuity.
It also increased the amount workers can save in a pension each year and still get tax relief, called an annual allowance.
Hunt also raised the amount people can put into their pension each year tax-free once they’ve started taking cash out of it at age 55: the annual money purchase allowance.
What is the lifetime pension subsidy?
This limits how much people can have in their pension fund without facing tax penalties, but the figure includes both the money they and their employer have contributed and any growth over the years.
It’s not a limit on how much can be paid in a pension, as savers can continue to pay above that amount, but will then be heavily taxed when they retire.
This is the verdict of Money pension expert Steve Webb
“For more than a decade, we have seen a series of large cuts in annual and lifetime limits for pension tax relief, which has meant that large numbers of people are unable to save more in a pension without incurring an additional tax invoice.
‘Today’s budget represents a step change in government policy and will free up millions of people to save more on their pensions. We are likely to see a ‘flood’ of new money into the pensions of top earners.
‘There will be an urgent need for these people to seek financial advice to ensure they are in the best position to take advantage of the much more positive regime that has just been introduced, perhaps even before the start of the next fiscal year and the new regime.’
Steve Webb is a partner at LCP and a columnist for This is Money, and was previously a pensions minister.
Any money above this level taken as income incurs an additional 25 percent charge and as a lump sum incurs a 55 percent charge, this is in addition to normal income tax.
The lifetime allowance was expected to rise to as much as £1.8m in the budget, but has now been removed entirely.
Why is the lifetime allowance so controversial?
When Labor introduced the lifetime allowance in 2006 it was £1.5m, gradually rising to £1.8m in the 2010/11 fiscal year.
However, it was later cut by Conservative Chancellors George Osborne and Philip Hammond, falling as low as £1m in 2017/2018.
If the lifetime allowance had increased in line with inflation since 2006, it would now be £2.66m, according to This is Money’s inflation calculator.
For someone with a defined contribution pension that is kept invested and used at a standard rate of 4 per cent per annum, the lifetime allowance of £1,073,100 equates to an income of £43,000.
Why discard life pensions?
The increasing restriction of a lifetime allowance that has been unable to keep pace with inflation, wages and pension increases has unleashed unintended consequences.
Higher-paid professionals, particularly much-needed experienced physicians, are opting to retire early rather than face tax penalties for overdoing it.
The government wants to keep people in the job market, and has thrown them a pension sweetener as a stimulus.
It seems that the Chancellor has searched for the biggest carrot he could find.
PensionBee’s Becky O’Connor on Chancellor removing lifetime allowance
The changes mean there is no limit to how a pension fund can grow without tax penalties.
Becky O’Connor, director of public affairs at pension firm PensionBee, said: “It appears the Chancellor has gone for the biggest carrot he could find when it comes to keeping experienced workers in the workplace, removing the allowance forever”.
‘The abolition of the lifetime allowance is a huge and unexpected move. For many, this will transform pensions from a complex planning nightmare to something they can rely on. Removing it entirely makes pensions easier all at once.’
But while the Chancellor abolished the lifetime allowance, he did not change the rules on how much can be taken out of pensions as a tax-free lump sum.
The rules are that 25 per cent of your pension fund in excess of the £1,073,100 lifetime allowance can be accessed without charge of tax, in other words £268,275.
Today’s Chancellor’s announcement freezes this cap indefinitely at that level.
What do the changes in the annual allowance mean?
The annual allowance is the standard amount that can be contributed to pensions each year and qualify for tax relief.
However, it’s not just the money you pay. It includes your contributions, your employer’s contributions, and tax relief.
The 25 per cent base rate tax break is automatically added to pension contributions, so without an employer paying a pension, someone could contribute £32,000 before reaching the current limit of £40,000.
The Chancellor has revealed plans to increase the annual allowance to £60,000.
There is also good news for high earners, whose annual allowance was previously cut to as little as £4,000.
The Chancellor today changed the phase-down rules so that even the highest income earners can save £10,000 with no tax impact.
The income threshold level, at which people’s annual income for the purposes of pension tax relief begins to be calculated, is £200,000.
But the annual allowance begins to taper off for people with an adjusted income level, including pension contributions, of £240,000.
What do the MPAA changes mean to me?
Workers over the age of 55 can take money out of their private pension and still save in it.
But if they take out more than £4,000 a year, they are hit with tax penalties under MPAA rules.
The Chancellor said today that the £4,000 limit would rise to £10,000 from April this year.
Jon Greer, head of retirement policy at investment firm Quilter, said: “While it might have flown a bit under the radar, it’s arguably the only change in the current pension landscape that will certainly help the masses in what When it comes to saving pensions and creating a return-to-work incentive is the MPAA’s increase.’
O’Connor said: “Increasing the annual allowance for money purchases is great for yo-yo retirees, who have to dip into their pension fund for a while, but then want to increase it again before retiring properly.”
The Chancellor’s MPAA changes really just bring him back to a previous level.
The MPAA was first introduced in 2015 at £10,000, before it was lowered to £4,000 in 2017.
Will the state retirement age change?
Rumors were circulating ahead of the Budget that the Chancellor might announce plans to raise the state retirement age to 68 by 2035.
However, this has not happened, yet.
Nor did it increase the age for the British to access their private pensions to 60 years, as suggested in various reports. This is currently 55, and is expected to rise to 57.
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