Chancellor Jeremy Hunt is anticipated to increase the annual and lifetime pension allowances in his Budget next Wednesday, in an effort to encourage older professionals to stay in or return to work.
According to reports, the Chancellor is anticipated to repeal the proposed “deep freeze” on the lifetime allowance for pensions and yearly pension contribution caps.
The annual and lifetime pension allowances, which are set at £40,000 and £1.073m, respectively, are limits on how much an individual can contribute to their pension each year while still receiving tax relief, build up in their pension, and then take out pension benefits before being subject to punitive tax charges on the excess.
Evelyn Partners managing director at wealth manager Jason Hollands says: “In the case of the LTA, investment growth is included so someone who has made wise investment decisions can be penalised with a tax charge which many will regard as unfair.
“This has created a disincentive for continued pension saving amongst higher earning professionals and is a factor driving early-retirement decisions at a time when the economy faces the challenge of tightening labour market.
“In particularly, restrictions on pension allowances – which have been reduced over the years both in nominal and real terms – have created well-documented problems in the public sector, especially in the NHS, where generous defined benefit pensions remain in place, meaning that many professionals retire early or are reluctant to take on further work.
“But without a rethink, the LTA is becoming a greater issue for those with defined contribution pension schemes who have saved diligently over a long period, and this will only escalate at current rates of inflation. If we have to have an LTA at all, it is certainly far too low, given that it stood at £1.8m just 10 years ago and that since then inflation means incomes and savings have soared.
“Hunt could also look at the money purchase annual allowance in his effort to get some older workers who have taken early retirement back into work. The MPAA is triggered when a saver accesses their pension flexibly, as many early retirees do, and means that the annual amount they can save into a pension while benefitting from tax relief drops from £40,000 to £4,000, putting a big restriction on rebuilding pension pots.
“Triggering the MPAA also wipes out your ability to mop up unused allowances from the three previous years under carry forward rules. Whether or not it encourages older economically inactive cohorts back to work, we would welcome a boost to the limit as it is an obscure tax trap that catches out a lot of otherwise financially astute savers.”
Another positive aspect of this is that it indicates pension tax reliefs could be left alone again, says Hollands: “There has been relatively little speculation ahead of next week’s Budget over the vulnerability of pension tax reliefs, despite interventions from a couple of think tanks , and indeed it looks very unlikely that Hunt would raise allowances with one hand and cut tax relief with the other.
“It would also be unpractical to be able to implement such changes so close to the new tax year, as well as politically risky for Hunt to target the tax benefits of private pensions after the significant tax crunch announced at the Autumn Statement, and on top of the likely acceleration of state pension age increases.
“Pension tax reliefs for higher and additional rate taxpayers – the proverbial cat with nine lives – look set to survive for now but their long-term survival should not be taken for granted. ”
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