Jeremy Hunt delivered a tax bonanza to 2mn of the highest-earning pension savers in an attempt to stem the wave of early retirement, a core tenet of the chancellor’s “back to work” Budget.
The big surprise in Hunt’s speech was scrapping from April the lifetime allowance of £1.073mn on pension pots, which has limited the available tax savings.
The change removes a 55 per cent tax on withdrawals from pots of over the lifetime allowance, or 25 per cent plus income tax if removed as income. Hunt went much further than pre-Budget leaks that indicated he might raise the threshold to £1.8mn.
However, the maximum cash sum that can be taken from a pension without being subject to income tax will remain limited to 25 per cent of the current £1.073mn lifetime allowance, a maximum of £268,275.
The one exception is for those who protected and capped their pension pots before 2011, when higher allowances were in place.
“Today’s Budget represents a sea-change in government policy and will set millions of people free to save more into pensions,” said Steve Webb, a former pensions minister and now partner at consultancy Lane Clark & Peacock.
He added that the scrapping of the lifetime allowance immediately freed up two groups, those who had stopped saving for fear of breaching the lifetime allowance and those who had previously locked in “fixed protection” on condition of making no more contributions to their pensions.
From April the annual tax-free pensions contribution cap — which has been frozen for the past nine years — will also rise from £40,000 a year to £60,000, at a cumulative cost of £1.1bn over the next five years.
The annual allowance has been a particular issue for senior doctors who breach the threshold, often unwittingly, then face an income tax bill at the end of the tax year. But even Hunt’s unexpectedly generous intervention, still leaves the annual allowance much lower than its peak of £255,000 in 2010-11.
In more good news for the highest earners, the tapered tax-free allowance has been made more generous. Earnings at which the allowance starts to taper will rise from £240,000 to £260,000, to a minimum of £10,000 per year — up from a previous minimum of £4,000.
Under existing pension rules, those who held off saving in recent years because of fears over lifetime limits will be able to carry forward up to three years of unused annual allowances to increase the amount they can pay in.
And in a similar move, Hunt announced an increase to the money purchase allowance — the annual amount of tax-free money that people can contribute to their defined contribution pensions after they start claiming them — from £4,000 to £10,000.
The £6,000 increase will be worth an additional £2,700 of tax relief to someone earning more than £260,000, with a minority of the very high earners some of the biggest beneficiaries of the budget.
The total cost of the pension reforms is estimated at £205mn in 2023-24, rising to £1.16bn in 2027-28.
There was no change in the Budget to rules governing inheritance tax on pension pots, with current regulations allowing defined contribution funds unused at death to be passed tax-free to heirs.
Kay Ingram, a chartered financial planner, said changes to the money purchase allowance were particularly welcome because it is “little understood by savers” who are often unaware of the restriction that accessing a pension places on resuming saving later.
David Hearne, a chartered financial planner, said the biggest benefit of the tax changes comes to those who already have big pensions, and who will now not face a lifetime allowance charge. For someone with a £2mn pension, that is a saving of £231,725.
Consultancy Lane Clark & Peacock has estimated that more than 1.5mn non-retired people are either already over the £1.073mn lifetime allowance or could have expected to cross it before the chancellor changed the rules.
Including those able to save more following lifting of the annual allowance and the money purchase annual allowance, it is estimated that at least 2mn people will now be free to save more into a pension.
James Jones-Tinsley, chartered financial planner at Barnett Waddingham, said the chancellor must quickly clarify what happens to retirements currently being processed.
The lifetime allowance will be suspended in April for the new tax year. But the Treasury says it will be abolished only from April 2024. This creates scope for potential delays, argued Jones-Tinsley, noting that if the abolition of the allowance requires primary legislation, “Labour may look to stonewall the bill as it favours the wealthy. In that case, it may well become an unfulfilled promise in the next few months.”
Meanwhile, the current rules remain in place until April 6, including one that requires people reaching their 75th birthday with a pension pot of above £1.073mn to pay a 25 per cent charge. Bad luck for those with birthdays in the next three weeks.