Lifetime allowance changes - Introduction
In July the Government published draft legislation dealing with the abolition of the lifetime allowance (LTA) with effect from 6 April 2024.
The draft legislation provides for the introduction of two new lump sum allowances which will apply to an individual and are used when a relevant lump sum is paid in respect of an individual and at least part of that lump sum is tax free.
The new allowances are the lump sum and death benefit allowance of £1,073,100 (the same as the LTA immediately before its abolition) and the lump sum allowance of £268,275 (25% of the LTA immediately before its abolition).
More detail on the new lump sum allowances
The individual's lump sum allowance is used when the individual takes tax free cash in the form of:
- a pension commencement lump sum,
- uncrystallised funds pension lump sum (UFPLS),
- trivial commutation lump sum; or
- winding-up lump sum (as those terms are defined in the legislation).
The individual's lump sum and death benefit allowance is used when the individual takes tax free cash in the form of an authorised lump sum and also when a person receives tax free cash in the form of an authorised lump sum death benefit in respect of the individual.
Where part of a lump sum is taxable and part isn't, only the tax free element counts towards the relevant lump sum allowance.
Pension benefits will be taxed through the existing income tax structure for pension income. To the extent that a lump sum is taxable, it will normally be taxed at the recipient's marginal rate of income tax.
A "pension commencement lump sum" equating to 25% of the value of the benefits being taken can generally be taken tax free provided the individual has sufficient headroom available under both types of lump sum allowance. 25% of an UFPLS will also be tax free provided the individual has sufficient lump sum allowance headroom.
Any amount in excess of the limits will be taxed as pension income.
Lump sum death benefits paid within 2 years in respect of a deceased member aged under 75 will generally still be tax free provided there is sufficient headroom under the deceased individual's lump sum and death benefit allowance. Any excess will generally be taxed as income in the hands of the recipient.
LTA protections
The draft legislation contains extensive provisions dealing with individuals who currently benefit from the various statutory protections in relation to the LTA.
"Primary protection" will cease to exist, but will be replaced with a new set of protections.
For individuals with enhanced protection, their "applicable amount" for a pension commencement lump sum is the amount that could have been paid on 6 April 2023.
The deadline for applying for fixed/individual protection 2016 will be 5 April 2025.
Transitional measures
The Government plans to publish transitional provisions to deal with the situation where one or more lump sums have been paid in respect of an individual before 6 April 2024, but at least one further lump sum is paid on or after that date.
No intention to significantly expand pension freedoms
When the draft legislation was first published, the Association of Consulting Actuaries suggested that it would have the effect of extending to defined benefits the "pension freedoms" that have applied to money purchase benefits since 6 April 2015.
In its
Pension schemes newsletter 152 HMRC has confirmed that it is not the Government's intention to significantly expand pension freedoms.
Conclusion
As we prepare for the abolition of the lifetime allowance (LTA) and the introduction of new lump sum allowances in April 2024, the UK pension landscape is undergoing a transformative shift.
These changes, unveiled in the government's draft legislation, bring both challenges and opportunities for individuals and pension scheme providers.
Understanding the intricacies of the individual lump sum allowance, the lump sum and death benefit allowance, and the taxation implications for various scenarios is paramount.
The introduction of transitional measures and the preservation of certain protections, albeit with modifications, underscore the government's commitment to managing this transition smoothly.
Importantly, HMRC's assurance that there will be no significant expansion of pension freedoms in relation to defined benefits provides clarity in an ever-evolving landscape.
If you have any queries about the lifetime allowance changes, or any other UK tax matters, then please do get in touch.