Announced in the Spring Budget 2023, the Lifetime Allowance for pension savings will be abolished from April 2024. The Lifetime Allowance is the amount of pension savings an individual can accrue before a tax charge could apply. Transitional arrangements are in place for the current tax year, which means that the existing Lifetime Allowance charge is now set at zero.
The legislation that brings about the permanent abolition of the Lifetime Allowance will introduce a raft of changes to the way that lump sum pension benefits are taxed. As is often the case, the new rules are not straightforward, and present a number of planning opportunities for pension holders in a range of circumstances. We must stress that HMRC are still working with the industry to bring about the final framework for the new rules, and therefore the content in this article is based on our understanding of the rules as they stand currently.
From 6th April 2024, a new allowance, known as the Lump Sum Allowance, will place a limit on the amount of tax-free cash that can be taken from pension arrangements. The Allowance is set at £268,275, and is exactly 25% of the current Lifetime Allowance limit, which is £1,073,100. Those with Lifetime Allowance protections will have a Lump Sum Allowance based on their protected Lifetime Allowance level.
From 6th April 2024, whenever tax-free cash is taken from a pension, this reduces the available Lump Sum Allowance. To take account of payments of tax-free cash made before 6th April 2024, 25% of the amount crystallised when taking benefits will be used. This produces a monetary amount that is deducted from the new Lump Sum Allowance. If the individual has used up 100% of their Lifetime Allowance, then they will be deemed to have no available Lump Sum Allowance remaining.
The new rules may present an opportunity to draw further tax-free cash from a defined contribution pension scheme for individuals with specific circumstances. The starting point on the Lump Sum Allowance is to assume that everyone who took pension benefits prior to 6th April 2024 received 25% of the value of their pension as tax-free cash. Whilst this applies to most individuals, there are situations when this may not have been the case.
Those with Defined Benefit (Final Salary) pensions may have received less than 25% of the value of the pension as tax-free cash, either due to the way the scheme is structured, or if they decided to take full pension income and not draw available tax-free cash. Further tax-free cash could be available; however this may only be useful if an individual is close to the Lump Sum Allowance, and would otherwise not be able to receive 25% of a further crystallisation as tax-free cash.
Those who could benefit from the new rules can apply for a Transitional Tax-free Amount Certificate from their existing pension provider. Pension holders will need to obtain evidence from the scheme where the additional allowance was created, to support their claim.
The other key part of the new pension regime is the new Lump Sum and Death Benefit Allowance (LSDBA). From the start of the new tax year, an individual will have a LSDBA of £1,073,100, although those holding transitional protections may have a higher allowance. This allowance is designed to cover lump sum payments made during an individual’s lifetime, and in addition, also covers lump sum payments paid on death of the individual. These payments include Defined Benefit lump sums and Uncrystallised lump sum death benefits. Any lump sum payments made during an individual’s lifetime, or to beneficiaries, above the LSDBA, will be taxable at the individual, or beneficiary’s, marginal rate of tax.
The important point to note here is that the rules apply to lump sums only. In the case of a Defined Benefit pension, or some Defined Contribution schemes, the only option open to beneficiaries is to receive a lump sum payment. This could potentially mean that beneficiaries become liable to tax if the LSDBA limit is breached.
Individuals holding modern Defined Contribution pensions should be able to avoid any adverse consequences of the LSDBA, if the pension arrangement offers Beneficiary Flexi-Access Drawdown. Payments made under beneficiary drawdown are not lump sums, and therefore benefits are not tested against the LSDBA.
The final framework of the new pension rules is still in the process of being ironed out, and there could be further revision to the draft legislation before the end of the tax year. Our initial assessment of the draft framework is that the changes are likely to affect a relatively small number of individuals with specific circumstances.
Some pension holders could be entitled to additional tax-free cash, in particular if they have taken benefits from a Defined Benefit pension and did not draw the maximum available tax-free cash. Those with specific pension protection may also need to check to see whether the new rules carry any implications for existing defined contribution pension arrangements.
In addition, the new Lump Sum and Death Benefit Allowance could lead to more beneficiaries paying tax when receiving pension benefits following the death of the pension holder; however, this can normally be avoided by ensuring that Beneficiary Flexi-Access Drawdown is an option under the pension contract. It is important to note that not all pension arrangements offer Beneficiary Flexi-Access Drawdown and it is therefore worth checking that this is an option under an existing pension plan. If it is not an option, it may be worth considering whether the existing pension arrangement is appropriate, and if any action is needed to move the pension to an alternative plan.
It has always been important to complete an Expression of Wish declaration on a Defined Contribution pension, to guide the pension trustees on who you would like your pension benefits paid to. The new rules only strengthens the need to ensure a valid nomination is in place, so that the option to draw benefits under Beneficiary Flexi-Access Drawdown is available.
Speak to one of our experienced advisers to discuss the implications of the new rules on your pensions and whether you need to take any action.
