New pensions allowances explained

The tax year ushered in a range of changes to pension allowances, including a major change to the lifetime allowance. We recap what these are so you know how to take advantage of them.

In his Spring Budget chancellor Jeremy Hunt announced he wasn’t increasing the pension lifetime allowance, but scrapping it altogether in an effort to incentivise more people to remain in work for longer. 

That wasn’t the only positive pensions-related announcement in the budget though. These are the changes that have come into place. 

Take advantage of pension allowances to reduce your tax burden 

Pensions annual allowances have substantially increased, which opens up a new avenue for those looking to minimise their tax burden – especially as fiscal drag pushes more and more people into higher tax bands. 

The new pension allowance should help protect your investments from capital gains tax and income tax as they’re “wrapped inside a tax shelter”, says Laith Khalaf, head of investment analysis at AJ Bell. “The sooner you put your investments inside… the pension, the sooner the protection kicks in.” 

Income tax has been frozen until 2028, and increasing your pension contributions could be a way to stop you from creeping onto a higher tax band

This will be particularly beneficial for higher earners, with an income between £125,140 and £150,000. “Where you are employed, it may be worth exploring any tax-free or tax-advantaged benefits in kind that may be available via salary sacrifice to help reduce your taxable income down,” says  Mark Collins, head of tax at Handelsbanken Wealth and Asset Management. 

Increased annual allowance 

The pensions annual tax-free allowance increased to £60,000 from £40,000, which will allow workers to increase their pension contributions without having to worry about tax. 

The annual allowance is the maximum amount that can be paid into a pension pot without incurring a tax bill – including employee and employer contributions. 

“Raising the pension annual allowance to £60,000 could help many people build up their retirement nest eggs, especially if they are playing catch up owing to missing contributions in earlier years due to affordability or gaps in employment,” says Rob Morgan, chief investment analyst at Charles Stanley. 

“For those whose earnings vary greatly from year to year, it offers more scope to up-size contributions and better plan for retirement.” 

Additionally, workers will still be able to use carry forward rules, so from this year they will be able to pay £60,000 as well as £40,000 from the last three years. 

Lifetime allowance cap scrapped… 

From 6 April workers no longer face a cap on the amount they can save for retirement without being taxed. Previously breaching the lifetime allowance triggered a 55% tax charge. 

“This change is well overdue as interactive investors figures show the lifetime allowance would now be worth £2.3 million if it had risen with inflation since its introduction in 2006,” says Alice Guy, head of pensions and savings at interactive investor. 

“It was surprisingly easy to breach the old LTA limit, especially after a long working life with regular pension investing,” continues Guy. “Someone starting work at 20 and saving £500 per month until they reach retirement age at 68 could see their pension pot reach an amazing £1.2 million as even modest pension savings add up over time.”

The new lifetime allowance rules will allow doctors and public sector workers to continue working. 

… But the tax-free lump sum remains capped

There was a “sneaky cut to the pension tax-free lump sum” hidden in the Budget, says Guy. 

The sum you can take out of your pension without being taxed will be capped at £268,275, or 25% of the previous lifetime allowance limit of £1,073,100. 

“This is a change to previous rules which allowed pension savers to withdraw 25% of their total pension pot tax free,” says Guy. What’s more, this amount will be frozen so inflation will eat away at it.

Money Purchase Annual Allowance cap increased

The money purchase annual allowance (MPAA) cap has increased to £10,000 yearly from £4,000 before. 

This is the amount that can be saved into a pension once it has been accessed from age 55. Many people have unknowingly incurred a tax bill due to this allowance as they access their pension pot, particularly throughout the cost of living crisis. 

This change will benefit higher earners and basic rate taxpayers alike. “With life expectancies rising more of us will need to finance a long retirement and higher pension allowance and money purchase allowances will give pension savers the ability to save more,” says Guy. 

Tapered annual allowance changes

Previously those earning over £240,000 saw their annual allowance fall from £40,000 to £4,000. 

But this has now been increased, from £4,000 to £10,000. The adjusted income threshold is also rising from £240,000 to £260,000. 

“This is a significant increase to the annual allowance which will particularly help those in defined benefit schemes with long service who get a promotion, as well as those whose earnings fluctuate,” says Andrew Tully, technical director at Canada Life. 

“As a policy clearly designed to encourage public sector employees to remain in work – primarily those in the NHS – it will be interesting to see how effective this change will be. Come what may, many higher-paid workers will benefit from this boost to the allowance.”   

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