Positive news for savers as the chancellor shakes up pension tax system.
It's fair to say few of us saw that coming.
Jeremy Hunt delivered his first spring budget today, outling his tax and spending plans for the year ahead. And while significant reforms to the pensions system were expected, after rumours surfaced earlier this week, the chancellor's decision to scrap the pension lifetime allowance (LTA) caught everyone by surprise.
That's not to say the surprise was an unpleasant one. The LTA has attracted controversy ever since its introduction in 2006 because of the heavy tax penalties levied for breaching it, and many have already expressed their delight at its removal.
The reason behind this decision, plus other measures within the 2023 spring budget such as childcare support, is to stop people retiring early or entice them back to work. Hunt claims this will spur economic growth.
The chancellor also unveiled further support to combat the rising cost of living, and laid out the UK’s economic forecast for the next few years.
Let’s take a look at the budget in greater detail, starting with the economic picture.
The UK economy
High inflation has been a problem for well over a year now, but forecasts suggest things might improve sooner than previously anticipated.
Inflation is set to fall from its current rate of 10.7 per cent to 2.9 per cent by the end of the year, with the UK now expected to avoid a “technical” recession. But before getting too carried away, the UK economy will still shrink 0.2 per cent in 2023, according to the Office for Budget Responsibility (OBR).
The longer-term outlook offers slightly more optimism. The OBR predicts the UK to grow 0.8 per cent in 2024, 2.5 per cent in 2025, 2.1 per cent in 2026, and 1.9 per cent in 2027. Meanwhile, it expects 170,000 fewer people will be out of work compared to its autumn forecast.
With households still facing enormous pressure from soaring energy prices, Hunt announced the energy price guarantee, which caps the average household’s utility bill at £2,500, will remain in place until June. The chancellor said this will save families an extra £160.
There was also good news for drivers and British pubs.
The decision to maintain the 5p fuel cut for 12 additional months will save drivers £100 over the next year.
Meanwhile, from 1 August the price of a pint in pubs is being slashed by 11p.
As noted above, the big news in pension circles was the decision to make tax allowances more generous, offering a boost to workers seeking to save for their future.
Positive reform to the pension system has been absent for almost a decade. Most allowances have been either frozen or reduced in recent years, restricting the tax benefits on offer.
Explaining his decision, Hunt said: “No one should be pushed out of the workforce due to tax reasons,” referring to the ongoing saga with the NHS where many senior doctors are retiring early to avoid heavy tax penalties on their defined benefit pensions.
The chancellor hopes that relaxing certain allowances will put a stop to this and tempt those already retired back to work. The aim is to plug the labour shortages, which is proving a significant drag on UK economic growth and productivity. Will it work and ultimately boost growth? We shall wait and see. Some have suggested the new allowances may encourage people to retire sooner, as you can now build your savings pot more quickly.
Here's a summary of the pension reforms:
The lifetime allowance (LTA), currently £1,073,100, is being scrapped
This means that there is no cap on what your pension can be worth to enjoy the full tax benefits. Under the LTA, any amount above the allowance is taxed at 25 per cent if drawn as income, or 55 per cent if taken as a lump sum. But now workers can now save without fear of breaching the limit and being hit with a painful tax bill.
There is, however, one sticking point. Under the new rules the amount you can draw as tax-free lump sum is being capped at 25 per cent of the current LTA, which is £268,275.
The annual allowance (AA) is rising from £40,000 to £60,000
The AA is a cap on what can pay into a pension every year and get tax relief. The higher allowance will be helpful to savers looking to make up for the lost time by paying hefty lump sums into their pensions in the years leading up to retirement.
It is worth noting that the 100 per cent of earnings rule still applies. So, if you earn £50,000 during the tax year, that’s your maximum annual allowance. You can pay more into your pension, of course, but you will not receive tax relief.
Meanwhile, the minimum tapered annual allowance, which restricts annual pension contributions for high earners, is rising from £4,000 to £10,000.
The money purchase annual allowance (MPAA) is increasing from £4,000 to £10,000
The MPAA is the amount anyone already retired taking income using income drawdown can pay into their pension and get tax relief. But whether this will tempt retirees back to work remains to be seen.
For those financially comfortable, the impact will be negligible. Let’s be honest, if you don’t have to work, the chances are you won’t. The higher MPAA might, however, benefit those needing to replenish any retirement savings unexpectedly drained by the rising cost of living. Either way, those of you already retired have more scope to beef up your savings in the future should you want to.
The government has long been under pressure to address childcare costs, with those in the UK among the highest in the world. As such, many parents of young children have found returning to work makes little financial sense, with earnings offset by childcare fees.
To support families here, Hunt announced a £4bn package which will provide 30 hours of free childcare a week for parents of children aged between nine months and five-years old, worth an estimated £6,500 a year for the average family.
To qualify both you and your partner or spouse must earn less than £100,000 a year.
Support for businesses
The government is pushing ahead with its decision to increase the top rate corporation tax from 19 per cent to 25 per cent. Although the chancellor said that only 10 per cent of companies will be impacted by the rise, it's a deeply unpopular policy among business owners.
Taking effect in April, it arrives at a time where business profits are already being squeezed by soaring bills and overheads.
Furthermore, owner/directors of limited companies will face a further pinch from April, when the dividend allowance – the amount in dividends you can receive every year without paying tax – will halve from £2,000 to £1,000, halving again to £500 from April 24.
But to soften the blow, Hunt is allowing businesses to deduct 100 per cent of investments in plants, equipment, and machinery from their profits for the next three years.
It is worth noting that businesses can also reduce their corporation tax bill by making pension contributions.
If you are concerned about how the spring budget might affect your finances, particularly regarding the changes to pensions, then it can be sensible to seek expert advice.
Match with a regulated financial adviser today.