The chancellor in his budget earlier this year seems to have finally listened to the growing cries regarding the pension rules and their effect on higher earning professionals particularly those in the NHS.
Higher earners have had several issues over the last few years particularly the ability to contribute into pensions which has, up until the budget, been curtailed by two restrictions.
- The Annual Allowance (AA) restricts the amount a person can pay into a pension during a particular year. Prior to the budget this was £40,000 per annum but could be reduced if earnings were over £200,000.
- The Lifetime Allowance (LTA) which capped the size of the fund that you can accrue during your lifetime – this was £1,072,100.
Whereas private sector workers caught within the restrictions could generally control their pension contributions, this was not the case for public sector workers, as their employers continued to contribute based on their earnings. This could mean that, additional shifts worked by consultants over a year to assist their employing hospital deal with peak admissions, would result in a large tax bill.
In practice, the only way a high earning public sector worker (such as a senior NHS employee) would be able to limit their exposure to Annual Allowance and Lifetime Allowance charges was to look to either restrict their earnings by choosing to work less, or of course retire. This is not good for the NHS, or the country.
The Chancellor has recognised this and, in the budget, announced changes that to a large extent address this. He stated that he would abolish the LTA and at the same time increase the limits for the annual allowance. Additionally, this change means everyone, not just health professionals can benefit from the relaxation of the regulations.
The detail of the changes are below:
- The Annual Allowance (AA) will increase from £40,000 to £60,000 from April 2023.
- When pension contributions in a year exceed the individual’s AA, the excess is taxed at the individual’s marginal rate of income tax.
- The available AA is also tapered by £1 for each £2 when income exceeds a defined limit. Following the budget this income limit will increase from £240,000 to £260,000 and, where tapering applies, the lowest amount the limit can be tapered to will be £10,000, up from £4,000.
- In addition, where a public sector worker is a member of both a closed and an open pension scheme, they will be linked, and the combined pension income will be calculated as if it were a single scheme. This enables the offset of negative real growth in legacy public sector schemes when calculating the AA.
- Before the budget, when first accessing a pension or on a person’s 75th birthday, pension funds were tested and if their value exceeded the LTA the excess figure was subject to additional taxation. Previously when the excess was taken as a lump sum, the tax was charged at a rate of 55%. Where the excess remained in the pension fund it was taxed at 25%.
Now there won’t be any LTA charge. The LTA limit will, however, continue to exist for the purpose of calculating the 25% tax-free lump sum available. This means that for most people the maximum tax-free lump sum they could have will be £268,275.
The relaxation of the rules is useful and will hopefully assist with the retention of senior members of the NHS. There are of course some issues which haven’t been addressed and are likely to be considered when the legislation is overhauled fully in 2024/25. These are:
- The Tax-Free Cash Limit is now frozen at 25% of £1,073,100. Whilst this is a significant figure today and we cannot guarantee what may happen in future, if this remains frozen then future pension savers may be significantly disadvantaged and need to pay additional tax.
- Whilst the removal of the lifetime limit is helpful, this, combined with the capping of the Tax-Free Cash means more retirement funds will be brought into being taxed over time.
- Some lump sum pension benefits may still be subject to taxation especially where they are paid from historic arrangements.
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