The pensions Lifetime Allowance and resulting tax charges were abolished under the UK’s 2023 spring budget. This was good news for those with larger pension savings, but life is never simple or static with UK pensions. Two new allowances – tax-free limits – are now set to replace it.
So, what does this mean for you and your beneficiaries?
The March budget only reduced the Lifetime Allowance charge to nil from 6 April 2023, with a commitment to fully abolishing it in the 2024 Finance Bill. HM Revenue and Customs (HMRC) has now published its draft legislation to abolish it, and this legislation also sets out how lump sums and lump sum death benefits will be treated from April 2024.
In other words, the Lifetime Allowance (LTA) is being completely removed but there will still be a form of limit, this time to how much can be taken as a tax-free lump sum.
We will have new levels of complexity to add to an already complicated and ever-changing regime. And as always, a reform made by one government could be overturned by a future one or a completely new system put in place. With a UK general election due before too long, there is some uncertainty over how this will develop over the coming years.
So far this is still draft legislation, with the final version due before Christmas. The details may change before it is finalised but, given the short time frame before implementation, it is worth seeking clarification on how the proposed rules could impact your planning, in case you wish to take any action before then.
New pensions lump sum limit
Under the draft legislation, with effect from 6th April 2024 two new allowances, the ‘lump sum allowance’ and ‘lump sum death benefits allowance’, will test lump sums and lump sum death benefits against a limit.
Lump Sum Allowance (LSA)
The Lump Sum Allowance will apply to payments made during your lifetime. In this case, the limit will be £268,275 (that is 25% of the old lifetime allowance of £1,073,100). It will apply to:
- Pension commencement lump sums (PCLS)
- Uncrystallised funds pension lump sums
- Trivial commutation lump sums
- Winding-up lump sums (but not transfers to QROPS)
Under current rules, you can take 25% of your pension fund – the Pension Commencement Lump Sum (PCLS) – tax-free.
Under the new rules, you can still do this, but you will need to have sufficient LSA for it all to be tax-free.
Lump Sum and Death Benefit Allowance (LSDBA)
This allowance applies to lump sums paid on death and is £1,073,100 (i.e., the same as the old lifetime allowance).
Under current rules, if you die before age 75, subject to meeting the designated to drawdown rules, your beneficiaries do not pay tax on the death benefits they receive.
From April 2024, the age of death is no longer relevant. In all cases, lump sum death benefits paid from uncrystallised or crystallised benefits will only be tax-free if below the deceased’s remaining LSDBA – £1,073,100 for those with no protections minus any Lump Sum Allowance you have already used.
Taxation if you breach the limits
When a lump sum is paid above the limits mentioned above, the excess is taxed at the recipient’s marginal rate of income tax.
For lifetime payments you will pay the tax, while for benefits paid on/after death, each beneficiary will be taxed.
No planned inflation increases
The draft legislation contains no mechanism for increasing these allowances, so it would be up to the government at the time to opt to raise it.
It is therefore likely that, over time, ‘today’s spending value’ of the tax-free proportion of your pension fund will be eroded by inflation and investment growth.
Lifetime allowance protection
The above limits apply to those without Lifetime Allowance protection.
If you have taken out protection, this is carried over. Your new Lump Sum Allowance and Lump Sum and Death Benefit Allowance will be based on your protected Lifetime Allowance. For example, a member with Fixed Protection 2014 will have an LSA of £375,000 and a LSDBA of £1.5 million.
The new rules do not have any impact on pension income. You will continue to be taxed as you are now.
If you transfer your UK pension out of the UK into a QROPS, at the time of transfer there are no UK income tax considerations. (Residents of Spain need to watch out for the Spanish rules, as is already the case.)
UK pension allowance – Looking ahead
The new rules are not set in stone and could be changed or overturned by a future government.
When the Lifetime Allowance was abolished in March, the Labour Party was quick to pledge to reinstate it, describing the move as “a Tory tax cut for the rich”.
With the polls looking encouraging for the Labour Party and the elections having to be held by January 2025, it may not be long before the UK has a new government. There may therefore be a limited opportunity to transfer your pension out of the UK and avoid any future lifetime allowance charges.
Since this article was published, and following the UK’s Autumn Statement, we now know there will be a third new allowance from April, the Overseas Transfer Allowance. Read our Autumn Statement article to learn more.
All in all, this is a good time to consider how you may use your pension benefits in the future and how any balance will be passed onto your family. Are there steps you can take now to protect or improve your pension savings? If you plan to enjoy your retirement years out of the UK, should you leave your pension in the UK?
Pensions are highly personal. Your decisions should be based on your circumstances, time horizon, objectives, family situation, risk tolerance, and the tax implications in both the UK and your country of residence. Taking the wrong approach could have unwelcome consequences, so take specialist cross-border advice from Blevins Franks covering both pensions and taxation.
Contact us now.
This article is a brief summary of complex draft legislation. Seek clarification on how the rules would affect your pensions.