In the run up to the Spring budget on 15 March 2023, many people were anticipating that both the lifetime allowance and annual allowance would be increased. As expected, the budget did increase all the various annual allowances. However, the Chancellor also made the surprise announcement that rather than increasing the lifetime allowance, he had decided to abolish it altogether*.

As more detail emerged, it became clear that individuals who held the more popular forms of transitional protection (enhanced protection or any form of fixed protection) would now be able to make further pension contributions without losing this protection. This meant that they will also retain their entitlement to higher tax free cash. 

Many of the people who hold transitional protection will be higher earners, increasingly affected by the long frozen inheritance tax thresholds. Many of these individuals will therefore wish to restart pension contributions to reduce both their income tax liability and the size of their estates. However, they may also have concerns about Labour’s pledge to reverse these changes.  

* For the 2023/24 tax year, the lifetime allowance charge will not apply, but the concept of the lifetime allowance will remain. It will then be fully abolished from 6 April 2024.

Case study – Jeremy

Jeremy (56) earns £200,000 a year. His estate is valued at £2.5m and he has a pension fund worth a further £1.7m. He previously took out fixed protection in 2014, protecting his lifetime allowance at £1.5m. At that point he ceased all pension contributions.

Upon reaching normal minimum pension age of 55, Jeremy took his maximum tax free cash entitlement of £375,000 and placed £1.125m into flexi-access drawdown. This used up 100% of his protected lifetime allowance. Since he has not subsequently taken any drawdown income, he has not triggered the money purchase annual allowance.

After the Spring budget changes, Jeremy is interested in restarting pension contributions to reduce his income tax liability, as well as the size of his estate for inheritance tax purposes. However, he does have concerns that the lifetime allowance could be reinstated if there is a change of Government.

After discussing with his financial adviser, Jeremy decides that he will restart making pension contributions of £100,000 a year, which will start immediately (before 6 April 2023).

Why now and why £100,000?

Contributing before 6 April 2023 – the contributions will be made before the new rules come into effect (6 April 2023). This means Jeremy’s fixed protection will be lost. However, Jeremy has already taken his enhanced tax free cash entitlement when he crystallised 100% of his lifetime allowance. Once the lifetime allowance charge is removed, he will have no further need for the protection. This means he can benefit from contributing immediately.

Contribution levels – Jeremy has never been subject to either the tapered annual allowance or money purchase annual allowance. He has also not made any pension contributions in the previous 3 tax years. He therefore has scope to make pension contributions of up to £160,000 in 2022/23 using carry forward. However, a £100,000 contribution will:

• Reduce his adjusted net income to £100,000, thereby fully restoring his tax free personal allowance and meaning that he no longer has to pay additional rate tax at 45%.
• Ensure his available carry forward of £40,000 from the 2019/20 tax year is fully utilised, as this would drop away after 5 April 2023.
• Only use £20,000 of the £40,000 carry forward available from the 2020/21 tax year. This leaves him with £60,000 of carry forward available to be used for contributions in 2023/24 and 2024/25.

How Jeremy will mitigate the risk of potential future Government policy

Before the next general election, Jeremy intends to fully designate his pension fund into nil-income drawdown. As he has no remaining tax free cash entitlement, this would not affect the tax treatment of his pension once the lifetime allowance charge is removed. However, it will mean that he has no remaining uncrystallised funds if a future Government decided to reinstate the lifetime allowance charge*. 

* Note that the net growth on drawdown funds is currently tested against the lifetime allowance at age 75 under BCE5A (this is the value at age 75 less the value at BCE1 when designated into drawdown).

Comment

Many high earners have pension rights that were affected by the lifetime allowance and they may have stopped making pension contributions some time ago. The removal of the lifetime allowance charge means that restarting contributions can make a lot of sense for these individuals. Often they will have scope to contribute significant amounts.

Careful consideration will be needed as to when new contributions should be made, whether tax free cash should be taken and when funds should be crystallised. Much of this will depend on whether transitional protection is present and if so, whether a higher tax free cash entitlement is still available.

Please note that the contents of this technical update is based on the Budget announcement and our understanding of the associated draft legislation and HMRC guidance published to date.

Important Information

Please note this is for general information only and is based on LV=’s understanding of the relevant legislation and regulations and may be subject to change.

The tax treatment of benefits depends on individual circumstances, and may be subject to change in the future.

The use of this document is at your own risk, and the content should not be used for the provision of professional advice.

LV= accept no liability for any damages, losses or causes of action of any nature arising from your use of this document.