How the abolition of the Lifetime Allowance could affect your retirement planning

Category: News & United Kingdom

In his March 2023 Spring Budget, the UK chancellor, Jeremy Hunt, surprised many financial commentators by announcing that the pension Lifetime Allowance (LTA) tax charge would be removed immediately. 

The LTA had previously limited the amount you could accrue in your pension fund, or funds, without incurring a tax charge penalty of up to 55% upon withdrawal.

By removing this, he granted some valuable flexibility to anyone saving for their retirement. The removal of the charge effectively allows you to save as much as you want in your retirement fund without any subsequent tax penalty when you start to draw from it.

To make the removal permanent, the chancellor went on to say that he planned to abolish the LTA altogether in a future finance bill. 

Discover how this key change to pension legislation could positively affect your retirement plan.

The Lifetime Allowance restricted your pension options

It’s important to first understand the limits that the LTA previously placed on your pension wealth. 

It meant that you could only accrue – through contributions and investment growth – a maximum of £1,073,100 in your pension fund without an additional tax charge being applied on top of any Income Tax due.

It was a restriction that adversely affected many pension savers. For example, a survey of higher-rate taxpayers, published by Professional Adviser, revealed that 16% of people said they had stopped paying contributions into their pension fund because of a fear that they would exceed the LTA.

That is no longer the case, and you may now be able to contribute into your pension without facing additional tax charges later.

The removal of the LTA increases the attractiveness of pensions if you’re a high earner as a way to save for your future. You can tax-efficiently contribute the lower of £60,000 or 100% of your annual income in the 2023/24 tax year, with no danger of a penalty tax charge on withdrawal.

One important consideration that will affect your plan is that, although the LTA tax charge has been removed, the maximum tax-free amount you can take from your pension has been frozen at its current level of £268,275 – 25% of the previous LTA amount. Note, however, that if you have previously applied for LTA protection your tax-free lump sum may be higher than this.

This means that although you can accrue a large pension pot without an LTA tax charge, you’ll need to pay careful attention to your tax-free amount when you begin drawing from it.

The changes to the Lifetime Allowance could affect your retirement plan

This key change could well have a beneficial effect on your plans for retirement. 

For example, you may have previously had to stop pension contributions as you were close to exceeding the previous LTA amount. Instead, you can now resume contributing, and even increase the amount you pay into your pension fund. 

Indeed, the same Professional Adviser survey confirmed that those planning to increase contributions were going to do so at an average of £650 a month. 

As well as stopping contributions, you may have also stopped working as a precursor to retirement. Instead, the removal of the LTA could mean that you’re able to resume working for a period and take the opportunity to top up your pension fund from your earnings. 

You have the opportunity to give your retirement income a timely boost

Removal of the LTA has come at an opportune time considering the external factors currently affecting your retirement plans. 

For example, the recent high levels of inflation, and a consequent reduction in the purchasing power of your accrued fund, could prompt you to reconsider income assumptions you may have had regarding your retirement fund – both in terms of the income you will be drawing and how long your fund will need to last. 

So, you can see the LTA tax removal as an opportunity to boost your retirement savings, so you can retire with increased confidence that you won’t outlive your fund.

You should review your estate plan

As your pension fund will not normally form part of your estate for Inheritance Tax (IHT) purposes, the removal of the LTA could improve your ability to use your pension as a tax-efficient estate planning tool. 

For example, you may decide to maximise contributions into your pension fund and then use other assets to provide you with income in retirement. This would have the effect of reducing the net value of your estate, while protecting the value of your pension fund for your nominated beneficiaries. 

Although your heirs will be subject to Income Tax at their marginal rate on any pension fund they inherit if you die after the age of 75, your fund will have benefited from investment growth within the pension wrapper, which would have rolled up tax-efficiently.

This may not be a permanent change

As you read earlier, the chancellor stated that a future finance act will make the abolition of the LTA permanent. 

However, in the immediate aftermath of the Spring Budget the Labour leader, Sir Keir Starmer, promised to reinstate the LTA, and there have been no further announcements from any other Labour spokespersons to reverse that intention.

If Labour do win the next election – that needs to be held by the end of January 2025 – pensions are likely to be part of a wide-ranging financial review and part of a package of measures that will be announced by any incoming chancellor.

While the future of UK politics is unknown, it’s important to bear this uncertainty in mind and factor it into your plan. 

Get in touch

If you’d like to find out how the removal of the LTA tax charge could provide pension planning opportunities, please get in touch with us. 

Please note

The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.

This article is for information only. Please do not solely rely on anything you have read in this article and ensure that you conduct your own research to ensure any actions you may take are suitable for your circumstances. 

All contents are based on our understanding of HMRC legislation, which are subject to change.