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Financial insights and perspectives designed to help you navigate and understand change.
Earlier this year, the UK Government announced that the Lifetime Allowance (LTA) will be abolished from the start of the next tax year. It is one of the most significant proposed changes to pension legislation in recent years and is expected to have a wide-ranging impact on pension taxation and death benefits.
To understand how the changes may affect your retirement planning, we have taken the opportunity of preparing a short summary of the essential details you should know at this stage.
When you accesses your pension funds as an income (either as a drawdown or an annuity), any income withdrawals are subject to income tax at your marginal rate.
In simple terms, your marginal rate is the tax rate you pay on each extra pound of income you earn. If your pension is your only income, then after taking the tax free allowance into account, your marginal tax rate in England and Wales is:
• 20% for income between £12,571 and £50,270;
• 40% for income between £50,271 and £150,000
• 45% over £150,000
In Scotland, it is:
• 19% for income between £12,571 and £14,732;
• 20% for income between £14,733 and £25,688;
• 21% for income between £25,689 and £43,662
• 42% for income between £43,663 and £125,140
• 47% over £125,140
No change; this position remains the same.
Should you die before age 75, your pension can be passed to a nominated beneficiary who may choose to draw an income. The income drawn by the beneficiary is not subject to income tax.
Should you die before age 75, any income taken by a beneficiary from uncrystallised funds within your pension will be subject to income tax at their marginal rate.
Uncrystallised funds are those funds which have not yet been accessed in any way by you or your beneficiary/ies. Conversely, crystallised funds are those which have been activated in some way – usually when they have been cashed in through a lump sum withdrawal or via an income drawdown or annuity.
The position is not currently clear regarding the tax treatment of inherited crystallised/drawdown funds, but we may assume that the same rule will apply.
It is also not year clear whether beneficiaries who are currently eligible for tax-free drawdown/annuity will retain that right from 6th April 2024.
Should you die after age 75, your pension can be passed to a nominated beneficiary who may choose to draw an income (whether by drawdown or annuity). Any such withdrawals by the beneficiary are subject to income tax at their marginal tax rate.
No change; this position remains the same.
The government has proposed two new allowances which will determine whether lump sums taken from pensions are tax-free or subject to income tax.
Under the new proposals, everyone who holds a personal pension will be entitled to a lump sum allowance of £268,275.
Under the lump sum allowance, you can still withdraw 25% of your pension fund tax-free as a pension commencement lump sum (PCLS), up to £268,275. If you withdraw a lump sum exceeding your allowance, any amount exceeding the allowance will be subject to income tax.
If you hold any form of lifetime allowance protection (sometimes referred to as transitional protection), your allowance may be higher.
Currently, some pension withdrawals are permitted tax-free. Under the new rules, these will also count toward the allowance. These include uncrystallised pension lump sums (UFPLS), trivial commutation lump sums, and winding-up lump sums.
However, any tax-free element from small pot commutations currently appears to be excluded from allowance calculations.
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.
This is a combined allowance for both lifetime tax-free lump sums and tax-free death benefits. Therefore, the amount that could be paid to you tax-free as a lump sum death benefit will reduce by the amount of any tax-free cash amounts you take during your lifetime.
Again, LTA protection will continue to help by 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.