Will these changes give your retirement savings a boost?

DID you know that the pension system has been made more generous? 

It’s not often you can say that - many of the recent reforms to pension and savings rules have made it harder to secure the retirement you want. But changes announced in the Budget earlier this year extended the sums that can be saved inside pensions while tax relief applies. 

Among these changes, the Annual Allowance for pensions was expanded. This is the limit on what can usually be paid into a pension each year with contributions benefiting from tax relief. You can read how tax relief works here. The change meant that the Annual Allowance was raised from £40,000 to £60,000. 

This provides potentially very valuable extra room to save for your retirement, but whether you can take advantage of it depends on your circumstances. 

Who can benefit, and what difference could it make to their retirement? Here’s what you need to know. 

Who does it help?

Raising the amount you can save into a pension is only of use if you have the money to save in the first place.  

To benefit from the rise in annual allowance to £60,000 you need to have been already able to pay in at least £40,000 into pensions, so it’s likely that anyone able to pay in £40,000-plus into a pension will be a very high earner. 

With or without the annual allowance, contributions to pensions cannot exceed your earnings in a given financial year. This is limited to £3,600 if you don’t have any earnings. 

What could it be worth to you?

If you can take full advantage of the new, higher annual allowance - what benefit could it bring? 

To get an idea - imagine a person contributing to a pension with 10 years to go until they retire. If they were to pay in the full annual allowance, assuming they achieve 5% a year investment growth after fees, the extra £20,000 a year they could pay in over the 10-year period would result in an extra £252,926¹ in their pension by the time they retire compared to what would’ve been possible under the old annual allowance. Please bear in mind this is a hypothetical example and the value of an investment can go down as well as up. 

Were they to turn this extra money into an income via drawdown, based on withdrawals equalling 4% of their pension savings, they could expect an extra £10,117 of income per year, however this amount is not guaranteed.² 

The extra money held in their pension would also enjoy some protection from Inheritance Tax (IHT) in the event of death. Money held in pensions is normally considered to be outside of your estate for IHT purposes and can be passed on tax-free if you die before age 75. If passed on after age 75 it would be taxed as income to the beneficiary.  

A limit for the highest earners - but still more generous

For those lucky enough to earn very high amounts it may not be possible to pay amounts up to the Annual Allowance into a pension. A potential limiting factor is the tapered annual allowance. This gradually reduces the annual allowance of very high earners - the more you earn, the more your annual allowance shrinks. 

The changes announced in the Budget have made the tapered annual allowance more generous, but it still represents a significant constriction on pension saving for those affected. 

The allowance of £60,000 is ‘tapered’ downwards if your ‘threshold income’ (your annual income before tax less any personal pension contributions and ignoring any employer contribution) is over £200,000. If it is below £200,000 the tapered reduction will not normally apply.  

If your threshold income is above £200,000, then you need to check if your ‘adjusted income’ (your annual income - broadly all income that you are taxed on including dividends, savings interest and rental income - before tax, plus the value of your own and any employer pension contributions) is over £260,000. If it is, the annual allowance will reduce by £1 for every £2 that your ‘adjusted income’ exceeds £260,000. The Budget raised this threshold by £20,000. 

The maximum reduction is £50,000 which reduces the annual allowance to £10,000 (previously £4,000) but only once adjusted income reaches £360,000. You can read our guide for more information on how the Tapered Annual Allowance applies to your circumstances. 

This means that those with earnings above £200,000 a year may not be able to take full advantage of the £60,000 annual allowance, subject to their wider financial circumstances. 

Need extra support? 

If you aren’t sure how the latest pension reforms affect you, professional financial advice could help. Fidelity’s Advisers can support you with solutions and personalised recommendations based on your personal circumstances. Call us on 0800 368 6882. 

You can read more about your 2023/24 tax allowances here.

Source: 

^{1, 2} Fidelity International, July 2023

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Tax treatment depends on individual circumstances and all tax rules may change in the future. Withdrawals from a pension product will not be possible until you reach age 55 (57 from 2028). This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.