Where pension contributions for a tax year exceed the AA, the excess is subject to charge at the persons marginal rate of income tax. The available AA is also tapered by £1 for each £2 adjusted income exceeds a defined limit.
From 6 April 2023, the AA will increase from £40,000 to £60,000. The adjusted income limit will increase from £240,000 to £260,000 and, where tapering applies to reduce the AA for an individual, the minimum tapered AA will be £10,000 (up from £4,000). Therefore, from 6 April 2023, the maximum possible reduction to the AA is £50,000, i.e. anyone with adjusted income of £360,000 or more will have their AA tapered to the £10,000 minimum.
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.
As before, any unused AA can be carried forward for three years and utilised if the AA in a subsequent year is exceeded. For example, if you have unused AAs from any of the past three tax years these can be used in addition to your current year AA limit enabling you to increase your maximum tax-relieved pension contributions for the current year
For 2022/23 and earlier years, the LTA (£1.073m for 2022/23) is the maximum savings an individual can hold in a pension fund without facing penal tax charges when taking pension benefits. On a ‘benefit crystallising event’ (e.g., first accessing pension income or 75th birthday), pension funds are tested and, if their value exceeds the LTA, the excess is subject to a tax charge.
Up to £268,250 (25% of the LTA) can be taken as a tax-free lump sum when benefits are first drawn. The balance of the LTA can be used to acquire an annuity, or be drawn down as needed, in both cases subject to PAYE.
For any excess pension fund above the LTA, for 2022/23 and earlier years, there is a LTA charge when taking the funds. The amount of charge will depend on how the excess amount is accessed. When the excess is taken as a lump sum, tax is charged at a rate of 55%. Where the excess remains in the pension fund an automatic 25% charge applies - the lower amount reflects the fact that future withdrawal of those funds will be subject to PAYE.
An LTA charge can also arise when benefits are not accessed, e.g., on 75th birthday or death before 75th birthday – usually a 25% LTA charge on the basis that no lump sum is taken.
From 6 April 2023 onwards, the LTA charge will no longer apply in terms of calculating tax due on any excess pension savings: initial legislation will remove the LTA charge, with the complete abolition following in a later Finance Bill.
Importantly, the existing LTA limit of £1.073m will continue to apply for the purpose of capping the 25% tax-free lump sum. This means that for most people the maximum tax-free lump sum they could accrue will remain £268,275. However, where a pension protection is held, the maximum lump sum is 25% of the protected amount.
From 6 April 2023 onwards, instead of the LTA charge, if the excess pension savings are taken out in the form of a lump sum, they will simply be subject to income tax at the individual’s marginal rate (ie up to 45%). So, the effect of the change for high earners taking the excess as a lump sum is likely to be to exchange a 55% tax charge for one of 45% - an effective reduction of 10%: of course, those with a lower annual income may see a larger effective benefit.
The real tax reduction arising from the abolition of the LTA is for those who do not choose to withdraw the excess immediately as there will be no 25% charge. Drawing down on larger funds will be subject to income tax, but that was previously the case too.
There have been no changes to the Inheritance tax treatment of pensions funds. Therefore, to the extent that pension funds have not been withdrawn by the time the individual dies, the full value should pass to individuals nominated beneficiaries without an immediate Inheritance tax charge. If the individual dies before age 75, there will be no tax charges at all (income tax or inheritance tax) on the beneficiaries drawing the funds: where the individual dies after age 75, the beneficiaries will be liable to income tax at their marginal rate when the funds are drawn out.
Individuals who have protected their LTA in past years may have been restricted from adding new funds to their pot as a condition of that protection. From 6 April 2023, individuals who held protection for their pension before 15 March 2023 will be able to accrue new pension benefits, join new arrangements or transfer their savings without losing their entitlement to their higher protected LTA amount for the purposes of the 25% tax free lump sum.
When a person first accesses a pension of any kind to draw income, their available annual allowance for all subsequent years, for the purpose of defined contribution schemes, is automatically tapered to the MPAA, regardless of their income level. The MPAA will be increased from £4,000 to £10,000. Therefore, individuals who have already started to take pension income but have resumed or continued work, can again top up their pension funds from 2023/24 onwards.
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