A Deep Dive into Recent Pension Tax Changes in the UK

In March, the UK government announced changes to the tax regime surrounding pensions as part of the annual Budget.

In this piece, we take a deep dive into what these changes are, who they affect, what employers should be doing in response and ask: is this really a big deal?

What is changing?

Since 2006 there has been a concerted effort by the UK government to encourage saving into private pensions. This has been done through introducing favourable tax structures and of course the pensions auto enrolment regime that HR professionals will be familiar with.

The changes in the budget focus on the former, expanding the tax benefits (and removing certain tax costs) associated with pension contributions for high earners. The changes are in large part motivated by particular issues in the UK’s public health sector where senior doctors retire early because of the limitations on the pensions regime, particularly the lifetime allowance.

There are two key concepts at play in these changes:

  1. The lifetime allowance. This is the maximum amount that an individual can save into a registered pension scheme without incurring a tax charge when they draw down that pension. The tax charge operates as a percentage on any amounts in excess of the lifetime allowance.
  2. The annual allowance. This is the maximum amount of contributions towards a registered pension scheme (including both employer and employee contributions) that can be made annually before an additional income tax charge is levied. There are various mechanisms that allow the annual allowance to be increased or reduced. For example, the annual allowance tapers for high earners, such that those with an adjusted income of £260,000 or more per year (in the 2023/34 tax year) will gradually have their annual allowance reduced to a minimum of £10,000.  

The Budget makes the following changes from 6 April 2023:

  • The lifetime allowance (£1,073,100 in the 2021/22 tax year) will be abolished.
  • The annual allowance will increase from £40,000 in the 2021/22 tax year to £60,000.
  • The maximum tax-free lump sum on retirement will be capped at £268,275 (being 25% of the lifetime allowance in 2022/23, which has now been abolished).

There has been a great deal of attention in the UK press, presenting these changes as very significant. However, once we dig deeper, the reality is a bit more uncertain.

Firstly, the Labour party have indicated they will reverse these changes. With a general election likely to happen in autumn 2024, these changes may not be in place for long.  

Secondly, the abolition of the lifetime allowance requires legislation, in the form of the Finance (No. 2) Bill 2023. Until that point, the government is simply disapplying the lifetime allowance charge. While Finance Bills usually pass into law without issue, that is not an absolute certainty. 

Thirdly, while the removal of the lifetime allowance seems like a huge change for most, it is not a benefit that will be realised for decades. In that period, a lot can change politically and the lifetime allowance may even make a return. In the 17 years since it was introduced, the lifetime allowance peaked at 1.8m, reducing back down to 1m and then slowly increasing again to the 2021/22 level – so it is by no means a settled area of policy. This uncertainty means that while the lifetime allowance change will have some impact on employee’s pension planning now, it is unlikely to cause fundamental changes in approach.

Who will be affected?

These changes will primarily be relevant to two groups of employees (i) those with significant pension pots at or close to the now-abolished lifetime allowance and (ii) highly paid employees. In the private sector, the financial services and tech sectors are likely to have a disproportionate number of employees who stand to be impacted by these changes.

These cohorts, particularly in financial services, are often engaged and well-informed about their pension arrangements, so will likely be proactive in wanting to explore how their employers are adapting to these changes.

What should employers be doing?

Though there is some uncertainty about the impact of these changes, employers may still see an increased number of enquiries from employees looking to revisit their pension salary sacrifice arrangements to maximise their tax efficiency. For example, many employers offer a payment in lieu of pension contributions to high earners who would otherwise exceed the annual or lifetime allowances. That approach may no longer be desirable for some high earners, who may instead wish to take advantage of the increased annual allowance.

Each employee’s appetite to take advantage of these changes will be dependent on their expected pension pot on retirement and broader retirement choices and, given the uncertainty, we expect many employees will hold off requesting changes until there is greater certainty.

Pensions law is highly complex and this article by necessity presents a simplified view and is no substitute for detailed advice. If you would like to discuss how these changes impact on your business, please reach out to your usual GQ | Littler contact.

Information contained in this publication is intended for informational purposes only and does not constitute legal advice or opinion, nor is it a substitute for the professional judgment of an attorney.