Alice Guy looks at why Jeremy Hunt might raise the pension lifetime allowance limit and how other pension changes might affect you.
The spring budget is only weeks away and already the chancellor is busy conducting interviews and laying the groundwork for his announcements.
This weekend Jeremy Hunt spoke to The Times about trying to encourage us all to work for longer, rather than taking early retirement. He commented that older workers “can have an enormously rich life by continuing to make a contribution to the economy. It doesn’t have to be about going to the golf course.”
Speaking last week at the headquarters of Bloomberg, Mr Hunt said: “Total employment is nearly 300,000 people lower than pre-pandemic, with around one-fifth of working-age adults economically inactive.
“So, it is time for a fundamental programme of reforms to support people with long-term conditions or mental illness to overcome the barriers and prejudices that prevent them from working.
“So to those who retired early after the pandemic or haven't found the right role after furlough, I say Britain needs you and we will look at the conditions necessary to make work worth your while.”
His comments give us some important clues about the likely announcements to expect in the spring budget on Wednesday 15 March.
Working for longer
In theory, the rising state pension age should keep more of us working for longer. But, as usual in life, things aren’t always that simple. In fact, recent data from the Office for National Statistics (ONS) shows that more over-50s are leaving the workplace and not returning. In spring 2022, there were 386,096 more economically inactive adults aged 50 to 64 years than before the Covid pandemic.
It's a big headache for the government. Fewer workers could mean a smaller economy with lower productivity, lower tax revenues and possibly more people struggling on lower incomes.
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The rules on pensions are one factor that could be pushing doctors and some other higher-paid public sector workers to retire early. In addition, complex money purchase allowance rules make it difficult for older workers to return to the workplace. They’ll be penalised with a lower annual pension allowance of £4,000 if they start withdrawing a pension and later return to work and want to pay in.
Jeremy Hunt is considering increasing the hugely unpopular lifetime pension allowance in his spring budget, reducing the number of people that are hit with a 55% tax charge.
The lifetime allowance, which applies to defined benefit and defined contribution pensions, means you’re only allowed to invest a maximum of £1,073,100 in a pension fund before being hit with a 55% tax charge on the excess. The allowance is due to be frozen at the current rate until at least 2026, pulling thousands more into the tax charge.
The lifetime allowance has more than halved in real terms since it was introduced in 2006.
£1 million sounds like a huge amount to save but, because of the way it’s calculated, people with generous defined benefit pensions could trigger the charge more easily. The frozen charge is contributing to doctors retiring early, because the only way they can avoid a huge tax charge is to reduce their hours or quit their job.
Raising the lifetime allowance in line with inflation could mean that thousands of doctors can carry on working and ease some of the huge pressure on the NHS.
It would also help private pension savers who are nearing the lifetime allowance limit, or think they might hit it once their investments grow in value during retirement.
But the news isn’t all good for pension savers. Hunt is also likely to freeze pension and ISA allowances in his spring budget. This is effectively a tax hike as inflation has cut the value of those limits in real terms.
The annual pension allowance, which caps how much you can save into your pension each year, has been stuck at £40,000 since 2014. Before then it was actually higher, and was £50,000 when it was first introduced in 2011.
The rules are particularly onerous if you’re an older pension saver who’s trying to make up for lost time and pile thousands into your pension before you retire. The £40,000 limit includes employers’ contributions, although you may be able to use previous years’ unused allowances in certain circumstances. Check here for details because the rules are complicated.
The money purchase annual allowance is arguably even worse for pension savers as it further limits what already-retired people can pay into their pension. It’s capped at a measly £4,000 each year once you’ve started drawing a pension income. It makes it harder for workers who’ve retired early, then returned to the workplace to save enough for retirement.
If Hunt does freeze pension allowances for another year, then it will make it harder for some people to save for a comfortable retirement.
How to maximise pension allowances
If you’re affected by the lifetime allowance, then it’s important to get financial advice. The rules are complicated and there are various points when a lifetime allowance charge could be triggered.
If you’ve got a decent-sized pot that’s still below the lifetime allowance limit, then it’s worth keeping an eye on the rules. Some people can trigger a lifetime allowance even if their pot is worth a lower amount when they retire. That’s because your pot is tested against the limit at various points, not just when you retire.
If you’ve used up your pension allowance, or are nearing the lifetime allowance limit, then it may be worth considering ISA saving. The ISA allowance is £20,000 and is separate to your pension limits.
ISA's don’t benefit from pension tax relief when you invest your money, but they do benefit from tax-free investment growth and are protected from capital gains tax. You also won’t need to pay income tax on ISA income once you come to draw it.
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If you’ve got investments held outside a pension or ISA, then it may be worth thinking about using Bed and ISA rules before the tax year end. The tax trick works by selling your investments, then rebuying them inside an ISA wrapper. It could be particularly worthwhile this year as the reducing capital gains tax annual allowance means more of us could be caught in the tax net. See here for more details on how it works and why it could reduce your tax bill.
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