The pension lifetime allowance (LTA) recovery tax charge was reduced to 0% for 2023/24 and is due to be abolished from April 2024. Announced in the Chancellor’s Spring Budget, this seemingly simple statement is proving complicated to put into practice. In July, 41 pages of draft legislation were published setting out HMRC’s initial attempt at replacing this bedrock of pension legislation with a new regime.
Replacing the LTA will be two new allowances that lump sums will be tested against: a lump sum allowance of £268,275 and a Lump Sum and Death Benefits Allowance (LSDBA) of £1,073,100 (the same figure as the old LTA). Broadly, lump sums in excess of these allowances will be taxable. Sounds simple, but there are many questions about how these new limits will work in practice, and further draft legislation is still to come.
But one area of certainty has emerged. The draft legislation gives us an end date of 5 April 2025 for applications for fixed protection 2016 and individual protection 2016, nine years after their introduction. These fixed protections were introduced to protect individuals with large pension funds as the LTA was reduced over time from £1.8m. As the draft legislation proposes those with lifetime allowance protections will retain their entitlement to higher tax-free cash, and their LSDBA will be increased to reflect their protected lifetime allowance.
The consultation on the draft legislation for the removal of the lifetime allowance (LTA) has now closed. Industry has given its views and now we have to wait and see what changes – if any – are made to the clauses published so far. Of course, we’ve only seen part of the proposals: there will be more legislation to come dealing with transitional issues, and importantly, tax treatment of beneficiary’s pensions.
Some of the draft clauses we have seen include changes to the rules around the pension commencement lump sum (PCLS).
At the moment we all know that standard PCLS entitlement is 25% of the amount crystallised up to the available LTA. In the new rules, PCLS is tax free up to the permitted maximum, which is defined as the lowest of the “applicable amount”, the available Lump Sum Allowance (LSA) and the available Lump Sum and Death Benefit Allowance (LSDBA). In other words, whilst the LTA is being abolished, in simple terms, tax-free cash will be restricted to the same level as now, as will death benefits without tax.
In future, as the LTA is abolished drawings in excess of the LTA cannot be subject penal recovery tax, but it is anticipated that no registered pension scheme will in future permit drawings in excess of these allowances. It remains to be clarified how such ‘excess’ drawings would be treated or taxed.
In reality for SIPP customers, since 2015 they’ve had the option of taking lump sums above the level of PCLS in the form of drawdown income with the only consequence being income tax payable (within the LTA).
However, defined benefit (DB) pension schemes are likely to see a significant change. If there is no pension income being taken, then the permitted maximum tax-free PCLS will be zero under the new regime – but importantly PCLS could still be paid out under the new rules. Effectively you could withdraw the whole DB scheme as a PCLS payment, albeit subject to income tax. This is subject to further clarification and confirmation as the new rules are finalised.
There are scenarios where this may be attractive – for example if the LSA has already been used up in other schemes so no more tax-free cash is available anyway. For a client with a small DB scheme and plenty of drawdown elsewhere, taking the DB pot as a one-off taxable lump sum could be seen as a tidying up exercise.
Some with small DB schemes just over the advice threshold (£30,000) may want to access their pension pot but are unwilling to pay the advice cost. They may be prepared to pay income tax to get the whole lot out, rather than have a minimal scheme pension paid for years.
Whether this was intended or not, it would be a significant change in policy and potentially damaging to some of the safeguards put in place for those with DB schemes. Only time will tell if this small part of the draft rules remains unchanged come April 2024.
In conclusion, the abolition of the pension LTA has been warmly welcomed by many pension holders, however, in practice the new proposed rules appear to retain many of its features and limitations, as well as potentially introducing new complexity and some planning opportunities. We will be pleased to help clients navigate the new pensions landscape once the rules have been finalised.
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