Following months of speculation and u-turns, the UK government has honoured its manifesto pledge to stick with the pension triple lock – a stark contrast to 12 months ago.
Chancellor Jeremy Hunt confirmed in his Autumn Statement that state pension for 2023/24 will be increased by 10.1%, in line with September’s Consumer Prices Index (CPI) inflation figure.
Under triple lock rules, state pensions increase every year according to inflation, earnings or 2.5% whichever is highest. Wage growth figures for May-to-July 2022 came in at 5.5%.
The full financial implications of the rise are:
- The single tier state pension will rise from £9,627.80 a year to approximately £10,600 ($12,476, €12,093) a year – £203.85 a week;
- The maximum basic state pension, payable to those who reached state pension age before April 2016, will rise from £7,376.20 to approximately £8,121 a year – £156.18 a week;
- The cost of the triple lock is around £9bn next year; and
- With the personal income tax allowance frozen at £12,570 until at least April 2028, if there are future triple lock rises between now and then, the single tier state pension will be very close to the £12,570 figure, potentially dragging millions more pensioners into paying income tax.
Hunt also announced a review of the state pension age in 2023 – which could impact the retirement plans of people across Britain.
‘Unsustainable’
Steven Cameron, pensions director at Aegon, said: “Today’s confirmation of honouring the triple lock for 2023/24 means pensioners can breathe a huge sigh of relief after a white-knuckle roller-coaster ride of past disappointments, new promises and a series of u-turns. But next year’s increase could be its ‘last gasp’ as the current formula is looking increasingly unsustainable.
“Financially, it won’t have been an easy decision for the government looking to fill a £50bn fiscal black hole – every 1% increase in the state pension costs around £900m a year. And this isn’t paid for out of some fund built up in the past but from the National Insurance paid for by today’s workers.
“Honouring this manifesto commitment after ditching it last time round will provide much needed support for pensioners, many of whom are on low and fixed incomes and particularly vulnerable to rampant inflation. The government will no doubt have weighed up the reaction of pensioner voters if they scrapped the triple lock for a second consecutive year in the run-up to the next general election.
“But there’s a huge question mark over whether any party would recommit, in a future election manifesto, to paying the highest of price inflation, earnings growth or 2.5% year on year. In volatile times, using an average over three years or even paying out the average of inflation and earnings increases each year might be more sustainable for government and predictable for pensioners.
“The outcome of the review of state pension age is also to be published early in 2023 and on affordability grounds, this needs to be considered alongside the future of the triple lock.
Jon Greer, head of retirement policy at Quilter, added: “Reinstating the triple lock this year was ultimately the right move and it will go a long way towards supporting pensioners through these challenging times.
“However, the triple lock does not work for everyone, and perhaps it is time the government assessed whether there is a fairer way to raise the state pension going forward, while preventing more people slipping into the poverty net and having to choose between heating or eating.”
Shine a light on pension tax relief
The chancellor also announced an increase in taxation on the highest earners by reducing the threshold at which the additional rate of 45% kicks in to £125,140 from the current £150,000. A move which may see more make use of pension tax relief, which was left untouched by chancellor Hunt.
When savers pay into their pension, some of the money that would have gone to the government as tax goes towards their pot instead. This can help reduce the amount of tax they pay and be used to help boost savings for the future. This ‘tax relief’ is given based on the rate of income tax that they pay.
Aegon’s Cameron said: “While the freeze on thresholds for basic and higher rate income tax will create more tax take ‘by stealth’, there’s nothing stealthy about the cut in the additional rate threshold which rather than being frozen is being reduced from £150,000 to £125,140.
“This will cost anyone earning over £150,000 an extra £1,243 a year, in sharp contrast to the savings Kwasi Kwarteng’s mini-budget would have granted by removing the additional rate entirely. But in current conditions, it’s not surprising that those who can afford to shoulder a greater part of the burden of tax increases are being asked to do so.
“Note that the existing gradual phasing out of the personal allowance once individuals earn over £100,000 means earnings between £100,000 and £125,140 are already effectively taxed at 60%. It now means thereafter, the marginal rate will be 45%. Together, these higher rates of income tax make paying personal contributions to pensions, which get relief at full marginal rate, particularly appealing.”
Les Cameron, head of technical at M&G Wealth, added: “Those in that wealth zone will no doubt be looking to bring forward any taxable withdrawals to get this lower rate of tax and then look to organise their income to try and stay below £125,140.
“There are several ways this could be achieved – through pension contributions, assigning assets to others or making more use of tax wrappers. Those with a higher risk appetite may simply use the 30% relief available through venture capital schemes to reduce some of their increased tax liability.”
Anthony Whatling, tax partner at Evelyn Partners, added: “There is not a great deal most taxpayers can do about this. One route to mitigate exposure to higher and additional rate income tax is through making pension contributions, as these currently provide tax relief at the marginal rate.
“Those who have the option of contributing to their pension via salary sacrifice should certainly consider it as this system offers relief from National Insurance in addition to income tax. Annual bonuses can also often be paid direct into pensions, affording relief from taxation.”
Lifetime allowance escapes extended freeze
Lastly on the pensions front, the lifetime allowance (LTA) threshold was rumoured to remain frozen for an additional two years – but this has failed to materialise.
The standard lifetime allowance is already frozen at £1,073,100 until 2025/26, having been reduced from a peak of £1.8m in 2012. The freeze was widely expected to be extended until 2028 in line with other allowances and thresholds, but clarification might have to wait until the full Spring Budget.
Gary Smith, financial planning director at Evelyn Partners, said: “The current freeze is leading to more additional tax charges on excess amounts above the threshold when savers come to take their pension benefits or turn 75.
“The rate of tax paid on pension savings above the LTA is 55% if it is taken as a lump sum, and 25% if it is taken in any other way, for example draw down or cash withdrawals.”
Aegon’s Cameron added: “This means the maximum fund individuals can build up in their pension without paying a tax penalty is reducing year on year in real terms. While this may be seen as only affecting the wealthy, hundreds of thousands of middle earners including many in public sector defined benefit pension schemes are already facing genuine limitations on how much they can save in pensions.
“10 years ago, in 2012, the pensions lifetime allowance sat at £1.8m and this would have been much higher now if increased each year in line with inflation. So, while few would have expected the lifetime allowance to be unfrozen right now, there’s a glimmer of hope in the chancellor resisting freezing it for a further two years.”
