Pension tax changes spell good news for high earners
The recent budget has made radical changes to pensions tax, that has an effect on high earners, and on the options available to their employers to provide pension and death benefits. However, the changes are not all in place and there remains a clear political risk that they would be reversed after a change of government. In the meantime, tax has been reduced for those with the more generous pension arrangements, which adds flexibility for their employers.
In his budget speech on 15 March 2023, Jeremy Hunt announced that he was “abolish[ing] the lifetime allowance”, one of the two taxes that manage the level of tax efficient pension savings in the UK. He was doing this, he said, to avoid doctors and other high earners having to “retire early because of the way pension taxes work”.
As with all budget speeches, there was a little more flourish in these statements than the dull truth allows for, and many were quick to point out how little effect it would have on doctors who wanted to retire. However, there is no doubt that it is still a radical change, reversing a policy introduced by George Osbourne of limiting the lifetime allowance and that it still makes a great deal of difference for high earners and their employers.
Tax efficient pension savings in a tax registered pension scheme are limited in two ways – by the amount that can be contributed to a pension each year (the annual allowance) and by the total value of the pension fund when it is taken as pension benefits (the lifetime allowance). Any amount that exceeds either of those targets is taxed. The tax on exceeding the lifetime allowance, known as the lifetime allowance charge, has been taxed at 40%, or 55% if the money is taken as a lump sum.
What the Chancellor has done is set the lifetime allowance charge to zero from 6 April 2023. However, there are some caveats to this. Some situations where the lifetime allowance would be charged are now being charged under different tax provisions and, probably most importantly, the lifetime allowance itself still exists, which would make it easy to reintroduce a charge. The Treasury is looking to abolish the lifetime allowance as the Chancellor announced, but this is a complex process and we are not expecting these changes before the next tax year at the earliest.
This is clearly good news for high earners, who are those most likely to be caught by the lifetime allowance charge. However, lifetime allowance itself is still with us for now. In fact there are a number of reasons to be alert that the issue may not have gone away altogether, not least that the Labour Party have been quite vocal that they would reverse this policy if they were elected.
As well as being good news for high earners, this change makes a number of issues much simpler for their employers. The lifetime allowance causes a lot of complexities for remuneration and benefits for high earners, many of whom do not want contributions to a pension that may be heavily taxed, but have no right to be excluded from automatic enrolment. In addition, the lifetime allowance charge can have a devastating effect on death benefits under a life insurance scheme, and this issue has seen a lot of businesses move to look at other arrangements, such as excepted group life schemes, over recent years as the lifetime allowance has become less generous.
The uncertainties around these changes mean that decisions are not simple. However, the changes we have seen and the likely future changes will allow businesses much great freedom in considering pension and life insurance benefits for their senior executives.
Employers will have more freedom in providing pension and death benefits for high earners, but the system is still complex.