Pensions changes – how they work

Limits on pension tax relief and changes to inheritance tax 

For higher earners, the ability to contribute to pensions was historically curtailed by two restrictions. The Annual Allowance (AA) restricts the amount a person can pay into a pension during a particular year. The Lifetime Allowance (LTA), until its abolition, sought to cap the size of the fund that accrues during your lifetime.

From 6 April 2023 the LTA charge was abolished and the limits for the AA were increased. However, the underlying legal framework under which the LTA operated was not removed until 6 April 2024, when substantial new legislation was introduced, broadly dealing with tax arising on and after retirement and introducing new terminology.

Budget 2024 brought more drastic changes for pensions with the effective abolition of the inheritance tax (IHT) exemption from 6 April 2027. This was perhaps not surprising, given the prevalence of defined contribution schemes (which can be inherited), and the abolition of the lifetime allowance charge in 2023.

For help and advice on any pension tax or inheritance tax issue please talk to us.

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The effective abolition of the IHT exemption from 6 April 2027 was announced in the Autumn Budget 2024. The aim is to prevent pensions from being used as a tool for avoiding IHT. To learn how the rules are proposed to work from April 2027, understand who can pay the IHT and the interaction with business relief for IHT - read Pensions - retirement and inheritance planning

Where pension contributions for a tax year exceed the AA, the excess is subject to charge at the person’s marginal rate of income tax. The available AA is £60,000 but is tapered to a minimum of £10,000 once adjusted income exceeds a defined limit. Read how the AA works, including the money purchase annual allowance.

For 2022/23 and earlier years, the LTA (£1.073m for 2022/23) was the maximum savings an individual could hold in a pension fund without facing penal tax charges when taking pension benefits. Read how your historic LTA is still relevant, in that it impacts the maximum 25% tax free lump sum you are able to extract.

Planning ahead

The 2023 and 2024 changes were welcomed by higher earners looking to contribute more into their pensions and individuals who already had pension funds valued above the £1.073m LTA – particularly those who do not have a higher protected LTA.

How we can help

Therefore, in light of the Budget 2024 changes, for many individuals with large pension pots it may now be appropriate to revisit their established plans and update their Wills and letters of wishes (and consider using trusts) to ensure their families get the full benefit of any pension funds remaining at their death.

Leaving your pension fund to your children could in future trigger a combined income tax and IHT charge of up to 67% so there may well be more tax-efficient ways to pass on your wealth: for example, leaving your pension fund solely to your spouse will still be tax-free.

So, as well as revisiting Wills in relation to their pension, anyone with a significant pension fund would be wise to also consider lifetime gifting as part of the mix in passing on wealth. Read more about pensions, retirement and succession planning.

If you are looking for help or advice on pensions tax relief or any other pension tax issue please contact Chris Holmes or Elsa Littlewood.

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