The 2023 Spring Budget saw major changes to the pension tax system with increases to tax limits. This should mean the vast majority of those in active service will avoid tax charges.
The lifetime allowance and annual allowance are limits on the amounts which can be saved into UK private pension schemes without paying additional tax. The Spring 2023 Budget proposed a large increase to the annual allowance from April 2023, and the abolition of the lifetime allowance from April 2024 (with no charges being applied from April 2023).
This reverses the direction of Government policy since 2010, which had been to cut the lifetime and annual allowances, bringing more teachers, especially leaders with significant Teachers’ Pension Scheme service, into the tax net.
The lifetime allowance is a limit on the amount of pension benefit that can be drawn from pension schemes – whether lump sums or retirement income – which can be paid without triggering an extra tax charge. The lifetime allowance was £1,073,500 for 2022-23. Previously it was much higher, reaching £1.8 million in 2010-11.
The 2023 Spring Budget announced the abolition of the ‘lifetime allowance charge’ from April 2023, and the abolition of the lifetime allowance itself from April 2024.
The lifetime allowance did not affect many NEU members. For members of defined benefit pension schemes (like the Teachers’ Pension Scheme and Local Government Pension Scheme), the value of your pension rights is calculated as 20 times the pension that you have accrued under the scheme – so members needed a pension of well over £50,000 to breach it.
However, the limit on the amount of tax free cash which can be taken from a pension will remain at 25 per cent of the £1.0735m, so £268,375. This is again not an issue for most people, but its decoupling from the lifetime allowance leaves this limit vulnerable to further cuts, or non-indexation over time.
The annual allowance is a limit to the total amount of contributions that can be paid to defined contribution pension schemes and the total amount of benefits that you can build up in defined benefit pension schemes (including the Teachers’ Pension Scheme and Local Government Pension Scheme each year) for tax relief purposes.
The level of the annual allowance had been £40,000 a year since April 2014, but is being increased to £60,000 from April 2023.
Calculating the increase in value of defined benefit pension rights is complex. The Government use a ‘flat-factor’ method, with a factor of 16. This means that an increase in a person’s annual pension of £1,000 is deemed to be worth £16,000.
Even with a £60,000 annual allowance there is a slim possibility that the allowance level can catch teachers (especially leadership group) who get significant pay rises in late career when they have sizeable final salary service. If a member gets a large pay rise in a final salary pension scheme, the pay rise increases the total value of their pension rights.
Fortunately, members who exceed the annual allowance figure can carry forward any unused annual allowance from the previous three tax years. This should mean that most affected members face no tax bill in practice.