Jeremy Hunt made some positive changes to pensions in his recent Budget but I wonder…
– How much the law of unintended consequences will come back to haunt him?
– What might come back to haunt the rest of us?
– What new (and old) advantages can you benefit from?
There is more to the Budget than I can concisely explain in a short video, so if you have any questions, please let Adrian or I know.
Here’s my quick 5-minute video: https://share.getcloudapp.com/JrupxvgR
For a transcript of the video, keep reading:
In this video, I’m going to talk to you about this month’s budget. And there were some really big and positive announcements in there about pensions.
There’s a couple of caveats in there as well that I want to explain, and I think the biggest caveat is the law of unintended consequences. So let’s go through this. I’ve got a few examples as we go along.
The biggest headline grab was the pensions lifetime allowance, which at the moment is £1,073,000. And any pensions above that, you can be taxed at up to 55%. That puts a lot of people off and on the sixth of April, that’s just going to be abolished, all that is going.
Now, the real crafty change that the government have bought in alongside that, that was kept very quiet on the day was that tax free cash is going to be limited to £268,000 which is a quarter of that £1,073,000 figure. However, don’t let that put you off. I still think pensions are the most tax efficient vehicle you’ve got. I think the other point I’ll make there is they’re still exempt from inheritance tax. So they’re still the best vehicle for passing wealth down the generations as tax efficiently as possible.
The other headline grab was the pensions annual allowance which is even increasing from £40 to £60,000 pounds. So let’s have a look at how that might help somebody. Let’s say we earn over 100,000 pounds, you start to lose your income tax personal allowance, which is £12,570. So between £100 and about £125,000 pounds, you’re effectively paying 60% income tax, and you pay 45% income tax on amounts over the £125 so if you earn £160,000 pounds a year, as on the sixth of April, you can pay £60,000 pounds into your pension and actually only cost you just over £29,000 pounds with all of that tax relief you will get back.
Now there are various other games you can play here. And if you’re receive child benefit, you can make a pension contribution to bring your earnings down to the £50,000 limit there and claim your child benefit backs it so there’s there is quite a lot of scope here to use pensions quite craftily.
Another change further up the earning scale is the annual allowance taper. If you earn over £240,000 pounds, £40,000 you can pay into your pension gets slowly reduced down to £4,000 and on the sixth of April all those limits are going up and they taper comes down to £10,000 pounds. So that’s a material change and £4,000 pounds when you earn those kinds of numbers is neither here nor there. £10,000 certainly starts to help. So that’s definitely worth doing for those people that are affected.
Now back to the lifetime allowance. I’ll recap a bit on this as changed quite a bit over the years since it was introduced by Gordon Brown in 2006. So it’s going to be empty. There’s going to be no pensions lifetime allowance I think two tax years whilst we’ve got current government and whilst Rishi Sunak and his friends can hang on but as my caveat, I don’t know what the Labour government are going to do.
Let’s just assume it’s going to be a Labour Government and there’s going to be election in the next 18 months. or so. By the time we’ve had the election, and we’ve had a more than likely a labour budget. That’s probably going to be effective from April 2025 onwards.
What’s the lifetime allowance going to be there? I don’t know. Nobody does. I’m not going to speculate on that. Enjoy the fact that there isn’t going to be one for two years.
So the unintended consequence here is I think there’s going to be a lot of doctors, head teachers, higher earning public sector employees who are going to use this next two tax years as a golden opportunity to retire without any of those tax penalties apply.
The same goes for any annual allowance that’s changed over the years. So we know it’s going to go up to £60,000 for the next let’s say two again two years. What’s it going to be in two years’ time? Nobody knows. But enjoy that £60,000 while you can.
So let me explain why the government have brought about these changes. Let’s do an example here of somebody who’s works in the NHS, let’s say or a head teacher. They’ve done 40 years’ service and they retire on a salary of 104,000 parents. Their pension is formula. So that formula is 40 years’ service divided by 80 multiplied by their salary to produce an annual pension of £52,000 a year. And then you add on three times that pension as the tax-free lump sum. Multiply the pension by 20. Add on the lump sum. As far as HMRC are concerned the value of that person’s pension at retirement is just a shade under £1.2m and £1.2 million is more than the £1,073,000. So that £122, nearly £123,000 is going to get taxed at 25%, that person is going to get a tax bill of £30,000, nearly £31,000. That’s one of the reasons they’ve changed these rules.
Now the bigger reason they’ve changed the rules is the annual allowance.
So let’s look again at another example. Let’s say this person’s got 36-year service again, they could be in the NHS or head teacher. They’ve got a salary at the start of this period of £100,000 pounds and they got a pay rise during that time to £135,000. This happened a lot during lockdown, during COVID with doctors working longer hours overtime when they got hit with some enormous tax penalties. And let me show you how that’s happened.
The opening value for the this the year is again formula driven, let’s say they’re accruing benefits on this on a 60 of the scale. So 36 divided by 60 multiplied by the salary, when we go back, we have to add on inflation. So the value of that pension is just over a £1 million a year later.
There’s then 37 years’ service, but we multiply that by £135,000 So they’ve got just over a £1.3-million-pound pension. So that is an enormous difference in the space of 12 months. So they’re deemed to have accrued benefits of £322,000 pounds which is a lot more than £40,000 they’re able to take tax free. So this person gets a tax bill of near enough £127,000. That is why doctors have been declining work and have been retiring and refusing to do overtime and so forth.
The big message that comes out of this budget is you’ve got to use your tax allowances. You’ve got to do that make the most use of your pensions, ISA, dividends, capital gains, structure income in a lower tax earning spouse’s name. I’ve had a meeting with clients this morning and I’ve saved them £3,000 alone just on putting income producing assets in the lowest earning spouse’s name. I think the big message there is use all your tax allowances while you can.