Changes to the pensions lifetime allowance (LTA)
Pensions are a tax-efficient way to save. Each person receives tax relief on the money they pay in, tax-free growth during the period that they hold a pension, and the ability to access money tax efficiently in retirement (as a combination of tax-free cash and taxable income). There is no limit on how much can be built up within pensions; however, taxes may be applied upon drawdown.
The Lifetime Allowance (LTA), introduced in 2006, was a capital limit on tax-efficient pension saving. This limit (£1,073,100 in 2022/23), was applied to the total value of all pension savings held across all UK pensions and providers, excluding the state pension. This meant each person could build pension benefits that exceed £1,073,1000 but these would be subject to a ‘Lifetime Allowance Charge’. This charge created an effective 55% tax on benefits above the Lifetime Allowance.
In the 2023 Spring Budget, the Chancellor announced significant changes to LTA, including the removal of the Lifetime Allowance Charge from 6 April 2023, and the abolishment of LTA completely from 6 April 2024.
LTA still exists, and during the 2023/24 tax year pension schemes will continue to carry out LTA checks when benefits are crystallised; however, any crystallising amount that exceeds any available LTA will no longer be subject to the Lifetime Allowance Charge.
Instead, the government plans to introduce Lump Sum allowances. This way, any lump sum benefit payments such as lifetime allowance excess lump sums, serious ill-health lump sums, defined benefits lump sum death benefits, and uncrystallised funds lump sum death benefits are now charged at a person’s marginal rate of income tax.
If you applied for and held valid enhanced protection or any fixed protection (2012, 2014, or 2016) before 15 March 2023, you will be able to build further pension benefits, set up new arrangements or transfer your arrangements without losing protection. You will also be able to keep your entitlement to higher tax-free cash.
For any protection application made after 15 March 2023, you will be entitled to higher tax-free cash; however, you will lose your protection if you accrue further benefits, open a new arrangement except to receive a permitted transfer, or make a non-permitted transfer.
Taxes on pensions following the abolition of the lifetime allowance
From 6 April 2024, the LTA will be abolished, but there will continue to be limits on what can be taken as a tax-free lump sum, with everything else withdrawn to be taxed as income.
Following the release of the policy paper on the proposed changes, our pensions specialists have summarised the proposed changes to pensions tax legislation.
(Please note that this summary is subject to our interpretation and may change once there is further clarity on some matters) –
Implications for taking income (during life and on death)
Current rules
Proposed changes
When an individual accesses their pension funds as an income (drawdown/annuity), withdrawals are subject to income tax at their marginal rate.
No change; the position remains the same.
When an individual dies before age 75, any income taken by a beneficiary is NOT subject to income tax.
On death before age 75, it is expected that income taken by a beneficiary from inherited pension funds (beneficiary drawdown or a beneficiary annuity) will still not be subject to income tax.
For those with existing tax-free beneficiary pensions, the government has announced that these will retain their tax-free status.
It’s worth noting that the taxation of death benefits before the age of 75 is where there is most ambiguity on how the rules will apply. The hope is that the government will clarify the position before the end of the tax year, with time still to implement any changes as necessary.
When an individual dies after age 75, any income taken by a beneficiary (either via beneficiary drawdown or a beneficiary’s annuity) is subject to income tax at their marginal rate.
No change, the position remains the same.
Implications for taking lump sums (during life and on death)
Two new allowances have been proposed that will determine whether lump sums taken from pensions, either during lifetime or on death, are tax-free or subject to income tax:
1. Lump sum allowance
2. Lump sum and death benefit allowance (LS&DBA)
Individuals will still be able to take 25% of their pension fund (or a higher amount if you have any form of transitional protection) tax-free as a pension commencement lump sum (PCLS) as long as they have a sufficient lump sum allowance. If they withdraw a lump sum exceeding their allowance, they will be subject to income tax.
The lump sum allowance is set at £268,275 for those without transitional protection (25% of the current standard LTA). Anyone with Lifetime Allowance protection would retain up to 25% of their protected Lifetime Allowance as their LSA. For those with Enhanced Protection, their LSA will be set at the value of tax-free cash that would be paid on 5 April 2024.
The tax-free elements of the following three lump sums will also count towards the allowance: Uncrystallised pension lump sums (UFPLS), Trivial commutation lump sums, and Winding-up lump sums. However, any tax-free element from small pot commutations does not appear to count towards this.
This allowance will limit the amount of tax-free lump sum payable, both during an individual’s lifetime and on death, and will match the current LTA at £1,073,100 or any individually protected amount.
This is a combined allowance for both lifetime tax-free lump sums and tax-free death benefits. Therefore, the amount that could be paid tax-free as a lump sum death benefit will be reduced by any tax-free cash amounts you take during your lifetime.
Transitional protections
Going forward, LTA protection will only help in increasing the amount of tax-free lump sum available by increasing the amount of lump sum allowance and the lump sum and death benefit allowance. Lump sum allowances vary across the different types of protections so it is important to seek appropriate advice to understand your entitlement.
We expect more to be announced on these legislative changes in the coming months and will continue to keep you abreast of any further changes as well as planning opportunities to manage your pension in the most tax-efficient way.
If you would like more information or to speak with one of our wealth planning and pensions experts, please don’t hesitate to contact us.
Content on this page is provided for general information and is subject to change and does not constitute advice.
