THE Spring Budget changes have dramatically increased the potential for saving into pensions.
Following the announcement of these changes, the overall Lifetime Allowance limit on what can be held in pensions tax efficiently is in the process of being removed altogether. Meanwhile, the annual allowance for pensions - the amount that can usually be paid into pensions each year with tax relief applying - has risen from £40,000 to £60,000.
For those that can afford pensions contributions at those levels, the change to the annual allowance significantly raises the ceiling on what can be put aside for retirement. But other factors also mean the benefits might be limited in other ways.
Here’s what you need to know to work out if the latest pension changes will benefit you.
Saving £60,000 a year for retirement
Raising the amount you can save into a pension is only of use if you have the money to save in the first place.
To benefit from the rise in annual allowance to £60,000 you need to have been already able to pay in at least £40,000 into pensions, so it’s likely that anyone able to pay in £40,000-plus into a pension is likely to be a very high earner.
With or without the annual allowance, contributions to pensions cannot exceed your earnings in a given financial year.
Tapered annual allowance - another limit on saving
Another limiting factor on the potential benefit from the rise in the annual allowance to £60,000 is another, related, limit in the pension system - the tapered annual allowance. This gradually reduces the annual allowance of very high earners - the more you earn, the more your annual allowance shrinks.
The allowance of £60,000 is ‘tapered’ downwards if your ‘threshold income’ (your annual income before tax less any personal pension contributions and ignoring any employer contribution) is over £200,000. If it is below £200,000 the tapered reduction will not normally apply.
If your threshold income is above £200,000, then you need to check if your ‘adjusted income’ (your annual income - broadly all income that you are taxed on including dividends, savings interest and rental income - before tax, plus the value of your own and any employer pension contributions) is over £260,000. If it is above £260,000, the annual allowance will reduce by £1 for every £2 that your ‘adjusted income’ exceeds £260,000.
The maximum reduction is £50,000 which reduces the annual allowance to £10,000 but only once adjusted income reaches £360,000. You can read our guide for more information on how the Tapered Annual Allowance applies to your circumstances.
This means that those with earnings above £200,000 a year may not be able to take full advantage of the £60,000 annual allowance, subject to their wider financial circumstances.
The potential benefits
If you can take full advantage of the new, higher annual allowance - what could it be worth to you?
To get an idea - imagine a person contributing to a pension with 10 years to go until they retire. If they were to pay in the full annual allowance, assuming they achieve 5% a year investment growth after fees, the extra £20,000 they could pay in over the 10 year period would result in an extra £252,9261 in their pension by the time they retire compared to what would’ve been possible under the old annual allowance.
Were they to turn this extra money into an income via drawdown they could expect an income of around 4% of their pot in their first year of withdrawals - some £10,117. That’s based on academic work which suggests those withdrawing from investments can take 4% of their pot, increase this in line with inflation each year and expect their money to last for at least 30 years.2
The extra money held in their pension would also enjoy some shelter from Inheritance Tax (IHT) in the event of their death. Money held in pensions is normally considered to be outside of your estate for Inheritance Tax purposes, and can be passed on tax-free if you die before age 75. If passed on after age 75 it would be taxed as income to the beneficiary.
A limit on tax-free cash
One final consideration for those hoping to take advantage of the higher annual allowance is the tax treatment of those extra contributions. Money paid into a pension usually benefits from tax-relief, while withdrawals from a pension are taxed as income, with the caveat that 25% of money withdrawn is usually paid tax-free.
This means that 25% of the first £1,073,100 in your pension can be withdrawn tax-free and any money on top of that will all be taxed, in full, at your marginal rate of income tax.
So - if you want to take advantage of the new £60,000 annual allowance, consider whether this will push your overall pension savings above £1,073,100 - and bear in mind the extra tax applied above that level.
Do you need help?
While the recent changes to pensions have made the system potentially more generous, they have also added even more complexity. If you’re unsure how the changes affect you then consider getting some professional help.
The Government’s Pension Wise service offers free, impartial guidance to help you understand your options at retirement. You can access the guidance online at www.moneyhelper.org.uk or over the telephone on 0800 138 3944.
1, 2 Fidelity International, May 2023
Important information - This is for information purposes only and the views contained are not to be taken as advice or a recommendation for any product, service or course of action. Tax treatment depends on individual circumstances and pension and tax rules may change in the future. If you need advice about how any of this information applies to you personally, you should contact an authorised financial adviser.