One of the key drivers behind some of the changes to pension tax legislation announced in the recent Budget was to try and encourage workers over 50-years-old, who had left the labour market during the Covid-19 pandemic, to return to employment and extend their working lives.
Labour market participation in the UK rose steadily through the 2010s, partly driven by increases in the state pension age (especially for women).
However, in the wake of the pandemic the participation rate fell by around 1 per cent, undoing almost all the increase of the preceding decade.
While the UK’s working-age participation rate remains above the OECD average, most other countries' are back above their pre-pandemic rate whereas the UK's is still well below.
And most of that is driven by the over age 50 cohort. The pandemic appears to have driven some older workers to take early retirement, although at least some of that has been reversed due to the current cost of living crisis.
But there has also been a substantial increase in people citing long-term illness or disability as their main reason for inactivity.
A friendlier tax environment
The belief is some of these economically inactive people work for the NHS and other key public sector employers. That drove many of the pension tax changes in the Budget.
Many workers in the public sector, who benefit from defined benefit pensions were facing a twin tax charge, with annual allowance charges being levied year-on-year, alongside a lifetime allowance tax charge when benefits were taken.
To ease this position the standard AA was increased by 50 per cent to £60,000 a year from April 6 2023.
In an additional boost for those in the public sector, open and closed public service pension schemes for a given workforce are considered linked for the purposes of calculating the AA charge, with effect from April 6 2023.
This may allow members to offset any negative real growth in closed schemes against a larger increase in an open scheme.
These measures combined are estimated to cost more than £1bn over the next five years. This is a significant increase to the AA, which will particularly help those in DB schemes with long service who get a promotion.
For higher earners the rules around the tapered annual allowance were altered. From April 6 2023, the minimum TAA increased from £4,000 to £10,000, and the adjusted income threshold increased from £240,000 to £260,000.
The applicable AA reduces by £1 for every £2 of income above that new threshold of £260,000. That means the maximum reduction affects individuals with incomes of £360,000 or more, where the AA reduces to £10,000.
This change helps those with the highest earnings save slightly more into their pension or face a lower tax charge.
The bombshell announcement was the proposal to abolish the LTA. From April 6 2023 the LTA tax charge has been removed. The LTA will be fully abolished in a future finance bill, hopefully from the 2024-25 tax year.
This change reverses a decade of declining LTA, which discouraged higher earners from saving. The government hopes abolishing the LTA will help ensure individuals such as doctors are not disincentivised from returning to, or remaining in, the workforce.
