Pension savers could enjoy a triple boost to the amount they can save for retirement, with the chancellor expected to hike three pension allowances in his Budget tomorrow.
The lifetime allowance (opens in new tab) - the total amount that workers can build up in their pension pots before being slapped with a tax charge - is currently £1,073,100.
According to media reports, Jeremy Hunt could announce that the allowance will soar to either £1.5m or £1.8m.
Meanwhile, the chancellor is also rumoured to be planning to raise the pension annual allowance from £40,000 to £60,000, and the money purchase annual allowance (MPAA) from £4,000 to £10,000.
After years of cutting or freezing the pension limits, raising the allowances will come as a welcome surprise, with some experts calling it a “game-changer”, and a “win-win scenario for the UK economy and individuals”.
As well as encouraging savers to put more into their pensions and benefit from extra tax relief, increasing the pension allowances could potentially encourage older workers to go back to work.
Nigel Green, chief executive of deVere Group (opens in new tab), a financial advice firm, said: “[The changes] will likely spur millions of people into reviewing their pension saving plans as they seek to build up more funds for their retirement.
“The [lifetime allowance hike should also] encourage older people to return to the workforce, thereby boosting Britain’s chances of long-term economic prosperity.”
What is the lifetime allowance?
The lifetime allowance is a cap on the total amount of pension savings you can have; it includes all pensions, such as workplace schemes, final salary pensions and Sipps, except the state pension.
Breaching the lifetime allowance incurs a 25% or 55% tax charge on the excess, depending on how you access your pension in retirement.
The lifetime allowance had previously increased with inflation each year, reaching £1.8m in 2010/2011.
However, in recent years it has been cut or frozen, and it was announced in the 2021 Budget that the lifetime allowance would be kept at its current level until April 2026.
How much could I save if the lifetime allowance went up?
Savers with big pension pots, or those with generous final salary plans (especially those who work in the public sector), could save significant amounts of money from an increase to the lifetime allowance.
According to the wealth manager Quilter (opens in new tab), if the lifetime allowance does jump to £1.8m, this could result in someone who has a pension fund of £1.8m gaining around £181,725 due to saved tax.
Currently, someone with a defined benefit (DB) pension would trigger the lifetime allowance tax charge once their annual pension income hits £53,655 (assuming no 25% tax-free lump sum is taken). If the lifetime allowance rose to £1.5m, a DB saver would need an annual pension income worth £75,000 before they’re hit with the tax charge, according to the investment platform Interactive Investor (opens in new tab).
If the lifetime allowance was hiked to £1.8m, the annual pension income would be £90,000.
Alice Guy, head of pensions and savings at Interactive Investor, said the current measly lifetime allowance of £1.07m meant the tax penalty of up to 55% was “catching out hard-working doctors, senior teachers and civil servants and encouraging them to leave the workplace”.
What’s happening to the annual allowances?
The chancellor is expected to announce increases to the annual allowance and the MPAA in his Spring Budget.
The annual allowance is a cap on the total amount you can contribute to a pension each tax year - go above it and you face paying a tax charge. This covers personal contributions, employer contributions and tax relief, and is currently set at £40,000.
The MPAA applies to anyone who has taken money out of their pension. It limits the amount of money you can pay back into your pension pots each year to £4,000.
Experts say the £4,000 MPAA acts as a significant disincentive to work.
Jon Greer, head of retirement policy at Quilter, said that if the rumour of increasing it to £10,000 turns out to be true it will be a “major positive”. He added that people may be happier to dip into their pension so they can reduce their workload but crucially still stay working.
Will the changes get people back into work?
The jury is out over whether raising the pension allowances will encourage more people to go back to work. We will have to see the actual detail in the Budget when it’s announced tomorrow.
In theory, some NHS doctors or consultants who retired early to avoid breaching the lifetime allowance could return to work. This would particularly help the increasingly-stretched health service.
However, experts question how successful the policy would be. Becky O’Connor, director of public affairs at the pension provider PensionBee (opens in new tab), said: “It’s hard to see how these moves will get people back to work - once you’ve taken early retirement and worked out this is affordable, it’s unlikely that being able to put more in your pension would encourage you back.”
She added: “If someone has given up work early due to ill health before managing to build a decent private pension pot, then these measures are irrelevant - if you can’t work, you can’t work. Equally, for people on low or moderate incomes who are only paying the minimum into their pensions, the annual and lifetime allowances are less relevant anyway, as they are probably not likely to hit either of them, even at the current levels.”
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