Every so often, a government fiscal event reshapes the financial advice landscape.
It happened in 2004 when the Labour Party unveiled pension simplification, otherwise known as A-Day, and precisely 10 years later George Osborne dropped the bombshell that was pension freedoms.
It also happened last week. Towards the end of his 2023 spring budget speech, Jeremy Hunt announced plans to scrap the lifetime allowance (LTA), catching everyone in the financial industry off guard.
Pre-budget leaks suggested the LTA would return to its former high of £1.8bn. No one predicted it would be kiboshed. With major increases to the three annual allowances - standard, money purchase and taper – it proved the biggest budget for pensions in almost a decade.
Hunt hopes the sweeping reforms will plug the UK's labour shortages, with a big focus on NHS senior doctors, and has in turn afforded affluent indviduals the freedom to accrue pension wealth without facing heavy penalties.
However, the rules governing pensions remain complex. It has never been more important for those impacted to seek expert help to safely navigate the new terrain and avoid making harmful choices with their retirement savings.
Though as we have seen in the past, a growing need for advice is not always met with increased demand. The pension freedoms are a case in point. Some eight years after the freedoms were introduced, many savers are still dodging advice and managing their own drawdown pots in retirement, increasing the risk of running out of money too soon.
So how can we ensure consumers get the right support now that the government has allowed more freedom to build a pension pot? Let’s have a deeper look and dig out the areas where your clients might need the most help.
Before the budget statement, if you had asked advisers to list the areas of the pension system that need the biggest reform, removing or lifting the LTA would have been right up there. Many feel the LTA penalises those who save hard and invest wisely throughout their working lives.
But not everyone has come out in support of the decision to abolish it. The Labour Party has vowed to reinstate the LTA if it were to regain power, describing Hunt's move as a tax cut for the rich.
On Sunday 19 March, the Guardian reported that only 105 doctors left the NHS last year due to voluntary early retirement, challenging the chancellor's claims that scrapping the LTA can fix NHS labour shortages. The Treasury has since countered that removing the LTA will help to retain staff.
But whichever side of the argument you are on, in the absence of reform, the LTA risked treading a similar path to the inheritance tax (IHT) nil rate band, which by April 2028 will have remained static for 19 years.
The result is that IHT’s days as a tax reserved for super-wealthy have begun to fade, with more estates being caught in its net despite the introduction of the residence nil rate band in 2017. IHT receipts hit a new record high in 2022/23, totalling £6.4bn. In 2009 - the last time the nil rate band rose - the average home was worth £150,000, half what the same property would cost today, underlining the effectiveness of fiscal drag as a tax-grabbing ploy.
The LTA has experienced similar neglect, increasing just 7 per cent since 2016, and it is significantly lower than its previous high of £1.8m just over a decade ago. As such, the number of savers breaching its limit has soared. In 2020/21 a total of £382m was paid in LTA charges by 8,610 people, an 11 per cent uptick on the year before.
One complication to the new landscape involves tax-free cash entitlement, which is being capped at 25 per cent of the current LTA, or £268,275.
Meanwhile, HMRC has confirmed that those with existing LTA protections can accrue further pension benefits without losing their right to higher tax-free cash, if applicable.
The government is yet to offer much insight into its future plans for maximum tax-free cash entitlement. Common sense suggests it should rise annually in line with inflation. But when it comes to pension policy, it is fair to say common sense does not always prevail.
Rumours of the annual allowance rising from £60,000 to £40,000 were leaked on Tuesday morning, blunting the surprise come budget day.
At 50 per cent it's a sizeable uptick, but also worth noting that the annual allowance has been frozen since 2014. An increase was long overdue.
The higher allowance is good news for savers looking to make up for the lost time by paying hefty lump sums into their pensions in the years leading up to retirement. This may include those who previously paused contributions to avoid LTA charges.
Due to carry forward rules, from April your clients can pay up to £180,000 into a pension and get income tax relief at their marginal rate, providing they have the income to support it.
The highly controversial tapered annual allowance has gone up too. Under current rules, tapering stops once earnings hit £312,000, reducing the annual allowance to £4,000.
But the combination of the minimum taper rising to £10,000, the threshold for adjusted income increasing from £240,000 to £260,000, and the standard annual allowance rising has created significantly more scope for some high earners to plough money into their pensions. Tapering now halts once earnings reach £360,000.
From April, an individual earning £312,000 can pay £34,000 into their pension every year and get tax relief at 45 per cent. Over 10 years, that’s £300,000 more than under current rules. Once factoring in potential investment growth, we could be talking a £500,000+ boost to their retirement funds with no LTA charge to worry about.
This is, of course, a rare example. Only a fraction of the population can boast that level of income. However, those that do will likely form the 8 per cent of the population who do seek financial advice.
Restoring the money purchase annual allowance (MPAA) to £10,000 was a key component of Hunt’s ‘back to work’ theme.
Whether upping the MPAA will indeed entice retirees back into the workplace remains to be seen. I suspect the childcare reforms (covered below) will have a greater impact.
But extra scope to beef up retirement pots, either as an IHT-mitigating tool or to replenish funds unexpectedly drained by high inflation, is a welcome move regardless.
The new childcare measures were another of Hunt's headline announcements. Though they have been universally welcomed, and will provide much-needed support to many young families, they have also created a tax trap. This is something that advisers can help with.
If either parent earns £100,000 or more, the 30-hours of free childcare drops off a cliff edge. They get nothing. AJ Bell crunched the numbers and found that if one working parent of two children earns £101,000 a year, the total amount lost in childcare could be north of £27,000. The same parent would need a salary of £156,279 to pocket the same take-home pay.
As advisers know all too well, one of the best solutions to reduce net adjusted income is paying into a pension, which in this instance can bring serious benefits. If a parent earns, say, £120,000 a year, making a £20,000 pension contribution can enable them to retain free childcare, save 40 per cent in income tax, and retain their personal income tax allowance, which is reduced by £1 for £2 earned above £100,000. This is an example of where expert advice can be lifechanging.
With the top rate corporation tax rising from 19 per cent to 25 per cent in April for profits over £500,000, your SME clients could be facing higher tax bills from April. Those with profits under £50,000 will still pay 19 per cent tax corporation tax, with a marginal rate of 26.5 per cent applying on profits between £50,000 and £250,000.
The chancellor said only 10 per cent of companies will be impacted by the rise, but that calculation was made a few years ago. A figure of 20 per cent is probably more accurate. Those businesses will be seeking help to streamline their tax affairs.
The corporation tax hike comes at a time when small businesses are already seeing profits squeezed by the rising cost of living. What’s more, the dividend allowance is halving from £2,000 to £1,000 next month, and again to £500 from April 24, affecting owner/directors who draw a small salary and the rest of their income in dividends.
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. Advisers have a role to play here too. From April, company pension contributions, which are fully tax deductible, become more attractive to businesses with profits over £50,000.
I am sure many of you have already experienced a sharp uptick in client enquiries, wanting to know what they can do to make the most of the new allowances and benefits. Some might want to act quickly in case a future government reinstates the current restrictions.
Regardless of who is in power, we can safely say the landscape will change again in the future. What we don't know is whether these changes will be favourable.
In conclusion, Hunt’s ‘back to work budget’ may not be as seismic as Osborne’s freedoms, chiefly because it will affect fewer people, but it will have a major impact on advisers and clients alike. It is now incumbent on the profession to ensure taxpayers make the most of these new opportunities.
