Pensions tax relief

Information on pensions tax relief - annual allowance and lifetime allowance.

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.

Lifetime allowance

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.

Annual allowance

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.

Career average and final salary

The way pensions are worked out will have an impact on whether the annual allowance limit is triggered. Most teachers now have both ‘final salary’ and ‘career average’ service in the Teachers’ Pension Scheme.

A final salary scheme bases pensions on years of service and pensionable earnings at or near retirement. An increase in salary in late career will therefore increase the value of the whole of an individual’s pension rights.

Career average pensions treat each year of accrual as a separate unit – so what you get depends on earnings in that year. A subsequent pay rise should have no impact on previous years’ accrual. This means career average pensions are less likely to trigger annual allowance problems than final salary pensions.

But even if a teacher is currently a member of the career average scheme, any pay rise received will increase the value of their final salary pension rights – because final salary is based on when they leave teaching, not their salary when they switched into the career average scheme.

Premature retirement

In some cases, the employer can grant ‘premature retirement’ in the Teachers’ Pension Scheme because of redundancy or for efficiency reasons. In this case, the member’s pension is granted without any actuarial reduction for early payment. In the Local Government Pension Scheme, an unreduced pension must be granted if the member is made redundant or leaves for business efficiency reasons at age 55 or above.

There is no exemption from the annual allowance for redundancy. This has not proved to be a problem in practice. Use of the flat factor method means that a pension taken at an earlier age is not deemed to be of extra value. So, a premature retirement that grants existing pension rights without actuarial reduction for early payment does not count against the annual allowance. Giving extra years would count against the annual allowance.

Ill-health retirement

There is no blanket exemption from the annual allowance rules in cases of ill health. However, HM Revenue & Customs (HMRC) allow an exemption if their definition of ‘severe ill health’ is met. The NEU’s understanding is that the total incapacity definition in the Teachers’ Pension Scheme meets the ‘severe ill health’ definition. Therefore, the additional service credited is exempt from the annual allowance calculation.

Members who receive a partial incapacity benefit award will not be affected by the changes to the annual allowance. Partial incapacity benefit adds no additional service to the member’s pension and, as with premature retirement, the early payment of pension is not relevant for annual allowance purposes.

Financial advice

The annual allowance is an extremely complex area and members must seek independent financial advice. The NEU will not give individual advice on the annual allowance. Members seeking financial advice may be able to seek help through myRewards.

Further information on annual allowance is available from the Teachers’ Pension Scheme website.

Other issues

Money purchase annual allowance

If you start taking money from a defined contribution pension scheme, the amount you can pay into a pension and still get tax relief may reduce. The Spring Budget 2023 also saw an increase to the Money Purchase Annual Allowance (MPAA) from £4,000 to £10,000 from April 2023.

The MPAA only applies to contributions to defined contribution pensions and not defined benefit pension schemes.

Scheme pays

Scheme pays is a process that allows an individual to pay an annual allowance charge from their pension scheme. Broadly, where a member’s annual allowance charge is at least £2,000, schemes can be required to pay some or all of the charge, but must make a corresponding reduction in the member’s pension benefits. In other cases, schemes may agree to pay the annual allowance charge on a voluntary basis.

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In whatever capacity you work in education, there is likely to be an occupational scheme available for you.

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