It was a surprise to many, me included, when Jeremy Hunt announced that the lifetime allowance (LTA) would be abolished from 6 April 2024.
I remember back in 2006 (showing my age here) taking an exam called ‘pension simplification’ and since this date, there has been a vast array of changes to pension legislation, which, in my opinion, has led to ‘pension complication’, not ‘pension simplification’.
My initial thoughts on hearing of the abolishment of the LTA is that after nearly 20 years we might finally be moving towards simplification. However, after digesting the information, my hopes were short-lived, and I believe we are still in a world of ‘pension complication’, highlighting the importance of receiving professional advice.
New pension allowances
From April 2024/25, the LTA will be replaced by the following lump-sum allowances:
- Lump sum allowance (LSA) – There will be a cap of £268,275 (which is 25% of the current LTA) on the amount of tax-free cash you can draw down from a pension.
- Lump sum and death benefit allowance (LSDBA) – There will be a cap of £1,073,100 on the amount of tax-free cash and lump sum death benefits payable.
For individuals who have the old-style LTA protections in place, they will be able to benefit from higher allowances.
It has also been confirmed that any benefits taken by way of small pots, trivial commutation lump sums, or winding up lump sums will not have an impact on the LSA or LSDBA.
For individuals who have previously taken pension benefits, there are two possible methods of calculating any remaining allowances: there is a ‘standard method’ and an ‘alternative method’.
The workings behind these calculations are beyond the scope of this article. However, the ‘alternative method’ offers potential planning opportunities for individuals who haven’t sacrificed any of their defined benefit pension* income for a lump sum or haven’t taken any tax-free cash due to attractive guaranteed annuity rates.
To benefit from this potential opportunity and maximise the LSA in full, an individual must have sufficient uncrystallised funds – see the example below of how this works.
*Defined benefit pension – a type of workplace pension that pays a retirement income based on salary and the number of years of service.
Let’s assume Client A retired in August 2022.
The lifetime allowance in the tax year 2022/23 was £1,073,100.
They took a defined benefit pension income of £53,655 and no tax-free cash.
To calculate whether a person is subject to the LTA charge, the defined benefit pension income was multiplied by 20.
£53,655 x 20 = £1,073,100
Here, the LTA was used in full and as such, any additional funds taken from the pension would have been subject to an additional tax charge of either 25% or 55%.
After 6 April 2024
As they opted for a full pension and no tax-free cash, they are now entitled to a lump sum allowance (LSA) of £268,275 – which is 25% of £1,073,100, despite having used all their lifetime allowance.
However, to maximise this allowance in full, they would need to have an uncrystallised pension of £1,073,100.
If, however, Client A had an uncrystallised fund of £300,000, they would only be able to take a tax-free lump sum of £75,000 (25% of £75,000) and not the cap of £268,275, as this is the maximum allowance which is based on the value of an uncrystallised pension.
Furthermore, any lump sum paid in excess of £75,000 would be subject to income tax.
This example is used for illustrative purposes only.
Death benefits announcement
In July 2023, the Government announced its intention to apply income tax on any unused defined contribution benefits on death before age 75. The Government has since announced it will not proceed with this, and these benefits will remain tax free (provided they are within the permitted allowances).
The introduction of the new rules is not as straightforward as many may initially think, and it is important to have a solid understanding of the new rules.
Equilibrium can help you to navigate these rules. Please don’t hesitate to call us on 0161 383 3335 to see if we can help or book a free, no-obligation chat with one of our experts here.
This blog is intended as an informative piece and should not be construed as advice.