Abolition of pensions lifetime allowance and proposed replacement

In the March 2023 Budget the government announced plans to replace the Lifetime Allowance (‘LTA’) regime with a new set of rules with effect from 6 April 2024.

Recently there has been significant speculation about the nature, extent and impact of the proposed replacement regime. This speculation has not been helped by a lack of clarity in the draft legislation. So, care must be taken and talking to a professional adviser is crucial.

The ‘headline’ change is that the LTA is to be abolished and replaced by two new allowances – the ‘Lump Sum Allowance’ (‘LSA’) and the ‘Lump Sum and Death Benefits Allowance’ (‘LSDBA’).

The new LSA will dictate the amount of tax-free cash a person can receive from pension arrangements. The LSA maximum will initially be set at £268,275, which is 25% of the current LTA.

Those who have already taken their full tax-free cash entitlement under the current rules will not be entitled to a further allowance following the introduction of the new rules. Those who have taken some tax-free cash under the current regime will have that reflected in a lower LSA.

The second new allowance, the LSDBA, is relevant where a pension holder has died before the age of 75. Under the current regime any pension benefits passed by someone who died before the age of 75 had been free of income tax for the beneficiary, regardless of how they accessed it.

Under the new rules, there is a limit on the maximum that can be inherited as a lump sum (the LSDBA, minus any LSA used during the member’s lifetime), with the excess taxed to income in the hands of the beneficiary. However, if the beneficiary fund is moved into drawdown within two years of the death of the member, no tax will arise on income taken. This does seem to be an oversight in the legislation, and we can expect this to be changed either before the legislation comes into effect or by amendment subsequently.

Both proposed allowances are set to align with the current LTA limits; therefore, the LSA is 25% of the LSDBA of £1,073,100. However, those who have previously had an LTA higher than the statutory LTA under the fixed or individual protection rules, will maintain the value of their higher LTA under the new rules.

What may be comforting to those who have inherited beneficiary pensions is that the existing rules will be carried forward. So, there will be no further excess benefit tests under the proposed rules, the test having taken place on death (if before age 75) or at age 75, if death was subsequent to that age.

The above gives a summary of the main points that will be relevant for most pension holders; however, advice should be taken as to the possible effects, which will differ in each case.

Key planning points are:

  • Care should be taken where members have already taken benefits (before the new rules come into force) and still have undrawn pensions or have both defined contribution and defined benefit schemes. Under the new rules, taking income no longer uses up any allowances and a standard calculation is applied to how much has been taken as a tax-free lump sum previously. Thus, there may be the need to provide evidence of a member’s previous benefits to ensure they are not disadvantaged by the new rules and can take the maximum tax-free sum under the new LSA. 
  • Ensure expression of wishes nominations are up to date and add dependents as potential beneficiaries to ensure that the trustees can appoint income, if the member dies before age 75, rather than being limited to just a lump sum (which would be limited under the new rules).
  • Consider rebuilding pension funds that were previously limited by holding enhanced or fixed protection, as clients can now contribute to pensions without losing their protection.

It is entirely possible there will be amendments to the legislation therefore it should be reiterated that the above commentary is based on our current understanding of draft legislation.

Please note that we are not tax advisers and the any guidance given is based upon our understanding of current tax rules and practices. We recommend that you seek appropriate professional advice to gain certainty in the tax arena.

If you would like to discuss the information covered in this Wealth Insight, our Wealth Planning team are here to help.

Please contact us at [email protected] or email your investment manager to learn more.

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