How do I get the most out of my pension in 2023?

Annual allowance

Since April 2014, you have been able to contribute £40,000 to your pension annually, this can be increased if you did not use up your allowances in the preceding 3 years and were a member of a qualifying pension scheme.

From 6 April 2020, the standard annual allowance of £40,000 for pension contributions (the total of personal and employer contributions) was reduced by £1 for every additional £2 of an individual’s ‘adjusted income’ over £240,000 and can still affect you if your income from all sources is over £200,000.

Unused allowances from 2018/19, 2019/20 and 2020/21 can be brought forward and used in 2021/22.

This can affect you unexpectedly if you are a member of a final salary e.g. defined benefit (DB) or career average scheme. Should you breach the rules and pay too much, you will be subject to an annual allowance charge. Payment of this charge is the individual member’s responsibility and will be charged at your marginal rate of tax.

If the total of all your pension funds is likely to be at or near £1m by the time you retire, you should seek urgent advice.

Lifetime allowance considerations

Although funds invested within a pension can grow tax free, there is a limit, the Lifetime Allowance (LTA) on the total amount you can hold in a pension pot. Funds in excess of the limit will suffer penalty tax charges of up to 55% when you start to take pension benefits.

The LTA was reduced from £1.25m to £1m from 6 April 2016. You can elect for ‘Individual Protection 2016’ (IP16) to preserve your individual LTA at the lower of £1.25m or the actual value of your pension funds on 5 April 2016 (if they were above £1m on 5 April 2016).

As with previous reductions, individuals can also preserve the earlier £1.25m LTA by opting for ‘fixed protection 2016’ (FP16). Although all contributions must have stopped from 6th April 2016 if fixed protection is chosen.

The Government initially announced that the LTA would increase in line with the consumer price index each year from 6 April 2018. This was then changed and will remain at the current level of £1,073,100 until at least April 2028.

Stakeholder pensions

Stakeholder pensions allow contributions to be made by, or for, all UK residents, including children and grandchildren from birth.

You could make a net contribution of up to £2,880 (effectively £3,600 gross) each year for members of your family, even for those who do not have any earnings.

You could also make pension contributions in respect of family members who do not work i.e. have no relevant earnings or cannot afford them.

If you make contributions to your children’s pension schemes on their behalf, they get tax relief and the payments are treated as reducing their taxable income. It could help keep them below the £50,000 income threshold at which they can retain the child benefit.

The earlier that pension contributions are started, the more they may benefit from compounded tax-free returns.

Pensions freedoms

The popular pension freedom reforms that launched in April 2015 mean that people can now access their whole pension pot at age 55 and spend, save or invest the money as they wish.

Savers can withdraw the whole pot in one go, although you might mistakenly run up a huge tax bill, especially if you were only used to being taxed at the basic rate through an employer.

By withdrawing large portions of your retirement pot, the outcome may mean you move into a higher rate tax bracket.

Flexible access from age 55

Pension investors aged at least 55 (rising to 57 from 2028) will be able to access their pension fund as a lump sum.

From 2028 onwards, the Government’s intention is that the minimum pension age for private pensions should be ten years below the State Pension age. Although, they are not automatically linking normal minimum pension age (NMPA) increases to State Pension age increases at this time.

The increase to age 57 will not apply to members of the various firefighters, police and armed forces public service pension schemes (commonly referred to as uniformed services pension schemes).

The Government intends to introduce a protection regime to apply to all types of UK registered pension schemes (occupational and non-occupational schemes) that will allow benefits to be taken before age 57 (but not earlier than age 55) after 5 April 2028 where a protected pension age is held.

The protection regime will work by allowing anyone who is a member of a pension scheme by 5 April 2023 that had an ‘unqualified right’ in the scheme rules on 11 February 2021 to take benefits from their arrangement at an age below 57, to be able to take benefits at that younger age even after 6 April 2028. If protection does apply, this right will apply to all money paid into the arrangement.

The first 25% of a lump sum will be tax free and the rest will be treated as taxable income. This will be subject to income tax at the marginal income tax rate. Basic rate taxpayers need to be aware that any income drawn from their pension will be added to any other income received, which could result in them paying tax at 40% or even 45%.

You can also choose to take your pension in smaller lump sums, spread over time, to help manage your tax liability.

Since April 2015, some restrictions have been removed. Fully flexible drawdown will offer considerable freedom but highlights the need for expert planning advice.

Matters for consideration

If you are in a defined contribution scheme (DC or Money Purchase), you should consider your options now and check what your scheme offers.

If you were already in a flexible drawdown prior to 6 April 2015, you can move to the new unlimited regime and draw more income than the current maximum. However, that can lead to restrictions on further contributions.

Existing capped drawdown arrangements will continue, although they are currently limited to 150% of a benchmark annuity rate. It should be noted that adopting these new flexibilities will restrict your future ability to invest more into your pension scheme, so care is necessary.

The money purchase annual allowance (MPAA) is currently £4,000 and is triggered when taking income from your drawdown, not your Pensions Commencement Lump Sum (PCLS).

Reviewing your retirement plans

The new rules give considerable freedom of choice. Under the new rules, whilst nobody will be forced to buy an annuity at any age, those who wish to do so may find it the most appropriate solution for them.

Clearly, it has never been more important to make the right choices about your pension fund, both about how you should carry on saving and how you should take the benefits.

These decisions will affect you for the rest of your life. It is essential, especially for those nearing retirement, to seek professional advice.

Not only will an expert look at your pension fund, but they will consider your wider financial goals. They will also consider another aspect of the new freedoms outlined below.

Your pension pot: A tax efficient way of keeping it in the family

Important changes are also taking place with regard to how pensions are treated in the event of your death.

Retaining pension wealth within the pension fund and passing it to future generations is now an extremely tax efficient estate planning solution, as it combines tax free inheritance with tax free investment returns and potential tax free withdrawals. Indeed, it may even change the way we utilise our capital in retirement, possibly leading us to spend other funds before our pensions.

From April 2015, you can nominate who inherits your pension fund. It can be anyone of any age and is no longer restricted to your ‘dependents’. If death occurs before age 75, the nominated beneficiary can access the funds at any time, tax free. If the original policyholder dies after age 75, defined contribution pension funds can be taken in instalments or a lump sum and will be taxed at the beneficiary’s marginal rate as they draw income from it.

Additionally, the nominated beneficiary can appoint their own successor, allowing the accumulated pension wealth to cascade down generations, whilst continuing to enjoy the tax freedoms that the pension wrapper will provide.

Each time a pension fund is inherited, the new owner has control over the eventual destination of those funds.

Disclaimer

This article should not be construed as advice or a personalised recommendation. The most suitable solution for you will depend on your own personal circumstances.

No action should be taken without seeking further formal advice.

MHA Moore and Smalley is regulated by the Financial Conduct Authority. Our FCA registration number is 448716.