Should pension funding be impacted by the new allowances or even by the upcoming general election?
What are the new pension allowances?
Let’s start by looking at the new pension allowances.
- Tax-free cash is limited by the ‘Lump Sum Allowance’ (LSA), which is currently the same as 25% of the old pension Lifetime allowance (£268,275). But there are no further charges when benefits are taken other than income tax.
- On death before age 75, the ‘lump sum and death benefits allowance’ (LSDBA) limits the amount of lump sum death benefits that can be paid tax-free to £1,073,100. Tax can easily be avoided if the death benefit can be taken under drawdown or by purchasing an annuity. Therefore, its critical you check if your current pension scheme facilitates drawdown.
Contributing more than the amount that would provide the maximum tax-free cash (LSA) will simply mean there’s no further tax-free cash available on those savings, but there’s no tax charge for exceeding the allowance. If the rate of tax relief you receive on the contribution mirrors the rate of tax payable on your retirement income, funding above the allowance will effectively provide the same return as an ISA.
What are the three main reasons pensions remain so attractive?
- Income Tax relief at your highest marginal rate, with benefits taxed at potentially lower rates in retirement.
- Tax-free cash on withdrawals.
- Security for loved ones – death benefits are paid free from IHT.
Pension v ISA
When saving for retirement, a pension will in most cases provide better net returns than an ISA, purely based on the tax mechanics. Both enjoy tax free growth, but ignoring this, the pension outcomes will depend on three factors – 1) tax relief on the way in, 2) the tax rate on income withdrawn, and 3) the availability of tax-free cash.
Whilst you can now save without being penalised for the size of your accumulated pensions funds, new savings may not attract any further tax-free cash. Despite this, a pension can still be a favourable option provided the tax rate when benefits are taken is not greater than the rate of tax relief received when contributions are made.
Additional arguments for using a pension as your preferred retirement choice include:
- Pensions are generally IHT free, and therefore more attractive when transferring wealth to the family.
- Pension savings can be passed on via inherited drawdown, which means that chosen beneficiaries can continue to hold their inheritance in a tax favoured wrapper. Only a spouse or civil partner can ‘inherit’ an ISA with its tax benefits intact.
- Where pension savings are inherited on death after reaching age 75, they will be taxed at the beneficiary’s marginal rate of income tax, which may be lower than the member’s own tax rate. If the member dies before age 75, there may be no income tax at all.
New opportunities for pension funding for those with enhanced or fixed protection
If you have either enhanced or fixed protection you can recommence savings if you have not already done so without fear of losing those protections, provided they were in place on 15 March 2023. These protections are still valuable as they give a higher LSA and LSDBA.
Where fund values are below the relevant fixed protection limits, new funding can also generate more tax-free cash, up to their protected LSA. There is also an opportunity for those with fixed protection who have had their pension pots diminished by a sharing order on divorce to rebuild their pots and tax-free cash.
What if we have a change of Government?
Great question, but the usual guidance of planning with the current tax regime and not what we think it may be in the future still applies. Speculation suggests a Labour government may reintroduce the old pension lifetime allowance, but there has been very little detail to date on how they would do this.
If you are not currently close to the old pension lifetime allowance (£1,073,100) with your total pension savings, why wouldn’t you continue to maximise the current tax reliefs?
This means, specifically maximising the higher annual pension allowance of £60,000 or using “carry forward” to exploit unused pension allowances form previous tax years and contributing sums in excess of £150,000 (ensuring this would still be tax efficient).
This may be a particularly attractive strategy for business owners who can also potentially benefit from a higher rate (25%) of Corporation tax relief on contributions.
If you have any questions relating to your pension, please get in touch on 01825 76 33 66 or via the form below.
