Rachel Vahey, head of policy development for AJ Bell, looks at the new pension tax regime following confirmation in the Autumn Statement that the lifetime allowance will be abolished from April 2024.
We are now one step closer to understanding how the new pension tax regime – to replace the lifetime allowance – will work in practice.
Instead of one lifetime allowance, savers will have two new main allowances to contend with. These allowances are designed to limit the pension tax-free lump sums people can receive in life and the tax-free lump sums they can pass onto beneficiaries when they die. Where previously pension withdrawals over the lifetime allowance could be subject to a lifetime allowance tax charge, savers can now take as much income as they want from their retirement pot, with just income tax to pay on pension withdrawals.
However, anyone hoping the decision to scrap the lifetime allowance would lead to radical simplification should think again, because these rules are far from simple. There are over 100 pages of new legislation and advisers have four months to get to grips with the detail, identify which clients are affected and work with them to figure out the best way forward. Support services, providers and platforms will need to step up to help advisers, providing technical support on complex cases.
The biggest areas of advice will be around transitional arrangements for those who access their pension before 6 April 2024 and are close to the existing lifetime allowance. HMRC has finally filled in the blanks on how they will be treated in the new regime, but the hard work starts now in helping these clients make the most of their tax-free allowances.
These changes are expected to become law before April 2024. Labour has previously said it will reinstate the lifetime allowance, although it is far from clear how it would go about this. As we head into an election year, it is hard to imagine any new government completely reversing these detailed new rules, although further tweaks are always a possibility.”
What happens to people who have used up some of their lifetime allowance before April 2024?
The Finance Bill, published on 29 November 2023, confirms vital transitional arrangements for savers as the lifetime allowance is abolished from April next year and the two lump sum allowances are introduced.
Under the new rules, a saver’s available ‘lump sum allowance’ and ‘lump sum and death benefit allowance’ will be reduced depending on how much lifetime allowance they have already used up before 6 April 2024.
The calculation will be made the first time someone accesses their pension after April 2024. Usually, 25% of someone’s used lifetime allowance will be deducted from both their lump sum allowance and their lump sum and death benefit allowance. If someone has used 100% of their lifetime allowance previously, they won’t have any lump sum allowance or lump sum and death benefit allowance available.
However, some pension savers or their beneficiaries may be able to request that a smaller amount is deducted, to make up for the fact they previously took less than the 25% maximum.
Catherine used 60% of her £1,073,100 lifetime allowance before 6 April 2024:
- 60% x £1,073,100 = £643,860
Both Catherine’s lump sum allowance and her lump sum and death benefit allowance are reduced by 25% x £643,860 = £160,965:
- lump sum allowance = £268,275 – £160,965 = £107,310
- lump sum and death benefit allowance = £1,073,100 – £160,965 = £912,135
How we got here: the end of the lifetime allowance…and two new lump sum allowances
Last tax year, the lifetime allowance was £1,073,100, with the maximum amount of pensions tax-free cash someone can build up in their lifetime usually limited to 25% of this, or £268,275. Any excess above this lifetime allowance was subject by HMRC to a lifetime allowance charge of either 25% (if taken as income) or 55% (if taken as a lump sum).
In the Spring Budget, chancellor Jeremy Hunt said the government intended to abolish the lifetime allowance altogether. Changes brought into force in April for this year (2023/24) retained the lifetime allowance in the tax system but removed the lifetime allowance charge.
The lifetime allowance will be fully removed from the pension tax rules from April next year, leaving a tax regime where consumers can take as much income as they want from their pension (albeit still subject to income tax) and checks will only be made on lump sums taken.
Two main new allowances are being created under the plans:
- An individual ‘lump sum allowance’ set at £268,275 (a quarter of the current £1,073,100 lifetime allowance) – measuring the tax-free cash taken over someone’s lifetime
- An individual ‘lump sum and death benefit allowance’ set at £1,073,100 – incorporating tax-free lump sums someone takes while alive, plus any serious ill health lump sum and lump sums paid out when they die
There will be a third allowance – an overseas transfer allowance – also set at £1,073,100, measuring the value of pension benefits transferred to qualifying overseas pension schemes.
Someone who exceeds any of these allowances will see the excess taxed in the same way as income.