Dave Downie, technical manager at abrdn, explains the recent policy paper and draft legislation on the abolition of the Lifetime Allowance, including what we now know is changing from April 2024, what the testing regime will look like and how this will interact with existing protections.
On 6 April 2024 we will say goodbye to the lifetime allowance (LTA).
HMRC have issued draft rules for 2024/25 along with a policy paper on the abolition of the LTA making the future of pension planning a little clearer. The draft rules for 2024-25 have set out the tax treatment of pension benefits once the LTA is removed and when lump sums can be paid tax free.
What’s changing from April 2024?
The broad framework handed down from government for HMRC to implement is that the LTA will be completely removed, but a cap is to be maintained to limit what can be taken as a tax-free lump sum.
Everything else is to be taxed as income, which has led to the introduction of two new allowances for tax free lump sums.
The new allowances that advisers must familiarise themselves with are the Lump Sum Allowance (LSA) and Lump Sum and Death Benefit Allowance (LS&DBA), which place a cap on the amount of lump sum benefits that can be taken tax free.
Here is what paraplanners should know about the new allowances:
Lump sum allowance (LSA)
Existing rules mean that 25% of the pension fund can be taken tax free as a pension commencement lump sum (PCLS). The same applies from April 2024, but under one new condition.
The member must have sufficient lump sum allowance for it to be tax free, which has been set at £268,275 for those without protection.
In addition to PCLS, the tax-free elements of the following lump sums will also count towards the allowance:
- Uncrystallised pension lump sums (UFPLS)
- Trivial commutation lump sums
- Winding-up lump sums
The draft legislation doesn’t mention the tax-free element from small pot commutations, but the existing tax rules treat them the same as trivial commutations, so it is likely they will count towards the LSA.
Lump sum and death allowance (LS&DBA)
The second allowance is combined for both lifetime tax free lump sums and tax-free death benefits, and will be used to limit how much can be paid as a tax free lump sum. This allowance will match the current LTA at £1,073,100.
The amount available for lump sum death benefits will be reduced by any tax-free cash amounts the member had taken during their lifetime.
The following lump sums will be tested against the allowance:
- DB lump sum death benefits
- Pension and annuity protection lump sum death benefits
- Uncrystallised funds lump sum death benefits
- Drawdown pension fund lump sum death benefits (from capped drawdown)
- Flexi-access drawdown lump sum death benefits
- Trivial commutation lump sum death benefits
- Serious ill-health lump sums
- Pension commencement lump sums*
- The tax-free elements of:
- Uncrystallised pension lump sums (UFPLS)*
- Trivial commutation lump sums*
- Winding-up lump sums*
Testing
The abolition of the LTA means the current system of benefit crystallisation events (BCEs) will be greatly simplified as just the BCEs relating to lump sums will remain and previous LTA usage is no longer relevant.
It’s only the monetary amount of previous lump sums, which will be needed to test the amount of the new allowances available. The draft legislation doesn’t provide for any revaluation on previously taken lump sums, though there are still transitional rules to be published which could cover this.
Protection
Those with fixed or individual protection will have their LS&DBA set to their protected lifetime allowance with their LSA at 25% of that amount.
Those with primary protection will have their LS&DBA set to £1.8m increased by their primary protection factor. If they have registered PCLS rights, their LSA will be set to their uncrystallised A-Day rights, increased by 20%, less the amounts already taken.
Taxation
If a lump sum is paid which is greater than the LSA or LS&DBA the excess is taxable at the recipient’s marginal rate of income tax. For lifetime payments such as PCLS or serious ill-health lumps sums, the amount over the allowance is taxed upon the member. Lump sum death benefits exceeding the LS&DBA will be assessed against the beneficiary(ies).
The draft legislation issued just covers the new rules for lump sums. However, the accompanying policy paper highlights a significant change to the taxation of pension income. From 2024/25, pension income will always be taxable.
Consequently, inherited drawdown and annuities purchased from uncrystallised funds where the member died pre-75 will become taxable. This is in contrast to lump sums paid from the same funds which will be tax free within the available LS&DBA. This puts things broadly back to the position pre 2015s pension freedoms. So far, only pension death benefits from uncrystallised funds have been mentioned in relation to the income becoming taxable, so we await further details to see if this policy will cover pension death benefits from crystallised funds as well.
Looking ahead, while there is no formal consultation on these changes, HMRC will continue to work with interested parties via the LTA working group and advisers should look to stay abreast of key developments to support affected clients.
*also tested against the lump sum allowance
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