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 pensions and providers, excluding the State Pension. This meant an individual could build pension benefits that exceed £1,073,100 but these would be subject to a ‘Lifetime Allowance Charge’.
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 available LTA will instead be subject to a 0% tax charge, effectively eliminating the tax charge for exceeding the lifetime allowance.
Instead, any income in excess of the lifetime allowance, whether £1,073,100 or a higher amount if transitional protection applies, will be subject to income tax at the individual’s marginal rate.
If an individual applied for and held valid enhanced protection or any fixed protection (2012, 2014, or 2016) before 15 March 2023, they will be able to build further pension benefits, set up new arrangements or transfer their arrangements without losing protection. They will also be able to keep their entitlement to higher tax-free cash.
For any protection application made after 15 March 2023, individuals will be entitled to higher tax-free cash. However, they will lose their protection if they accrue further benefits, open a new arrangement except to receive a permitted transfer or make a non-permitted transfer.
From 6 April 2024, 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be abolished, but there will continue to be limits on what can be taken as a tax-free lump sum, with everything else withdrawn to be taxed as income.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.
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, if a beneficiary elects for the funds to be designated to a beneficiary drawdown or a beneficiary annuity, the income will be tax-free. If a beneficiary chooses to take the income as a lump sum, they can take up to the Lump Sum Death Benefit Allowance (the higher of £1,073,100 or protected LTA) tax-free, and the excess will be taxable at their marginal rate. Please note, if the pension holder had used some of their lump sum allowance during their lifetime, this would reduce the lump sum death benefit allowance for their beneficiary. If someone is already in receipt of a beneficiary pension that is currently tax-free, this will remain tax-free from 6 April 2024. |
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. |
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 (LSA)
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).
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.
2. Lump sum and death benefit allowance (LS&DBA)
This allowance will limit the amount of tax-free lump sum payable, both during an individual's lifetime and on death, and It is the higher of £1,073,100 or protected lifetime allowance.
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.
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.
You can listen back to our latest webinar in a three-part series where our pension specialists discuss how the Lifetime Allowance and Death Benefit taxation changes impact you.
Watch pension planning webinars
If you would like to speak with one of our pension specialists about any of the topics covered in this article, please do not hesitate to get in touch.
Pension funds have, for some time, been used as a tax-efficient way to pass wealth to future generations as they, in almost all instances, sit outside of an individual's estate. Pensions are therefore not part of Inheritance Tax (IHT) calculations and are not subject to the punitive 40% IHT rate.
Following the announcement that the Pensions Lifetime Allowance will be abolished from 6 April 2024, join our pensions experts as they discuss the proposed changes to how pension drawdown will be taxed and some significant changes to death benefits.
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