Pensions In The Post-LTA Era

The landscape of pension planning is finally getting clearer. With the Lifetime Allowance (LTA) on its way out, new draft rules and a policy paper have been published, outlining what's in store for 2024/25.

The move to eliminate the Lifetime Allowance could have been a game-changer, simplifying pensions for millions and removing a major roadblock to saving for retirement. While it still offers a boost for pension savers, the government seems to be complicating matters by introducing two new lifetime limits as well as contemplating a new 'death tax' for those who pass away before 75.

---

What's Changing in April 2024?

The LTA was retained for the current tax year but with the charge for exceeding it set to zero.

From next April though, the LTA will be completely abolished.

The broad framework is that the LTA is to 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.

This has led to the introduction of two new allowances for tax free lump sums.

The UK pension industry seems to have an obsession with acronyms. It's like they're trying to create a secret code that only they can understand. We have SIPPs, TFC, LTA and my personal favourite, UFPLS.

Now we have two new ones to add to our vocabulary, the LSA (Lump Sum Allowance) and the LS&DBA (Lump Sum and Death Benefit Allowance).

Lump Sum Allowance (LSA)

You can still take 25% of your pension fund as a tax-free Pension Commencement Lump Sum (PCLS, or Tax Free Cash in old money!), provided you have enough LSA.

The LSA is set at £268,275 for those without protection (this is 25% of the LTA as was).

In addition to PCLS, the tax free elements of the following lump sums, Uncrystallised Pension Lump Sums (UFPLS), Trivial Commutation Lump Sums and Wind-up Lump Sums will also count towards this allowance.

Lump Sum and Death Benefit Allowance (LS&DBA)

This second allowance, set at £1,073,100, will limit tax-free lump sums during your lifetime and upon death.

Various types of lump sums will be tested against this allowance, and any tax-free cash you've taken during your lifetime will reduce what's available for lump sum death benefits.

For example, if someone has a £1M SIPP and takes £250,000 tax-free cash, the maximum tax-free lump sum death benefit would be £823,100.

Any excess will be taxed at the beneficiaries' marginal rates.

Simplifying the Testing

With the LTA gone, Benefit Crystallisation Events (BCEs) will be simplified. The focus will now be solely on the monetary amount of previous lump sums to test the new allowances and previous LTA usage is no longer relevant.

However, it's also worth noting that the notion of crystallised and uncrystallised funds no longer has any bearing on what can be paid as a tax free lump sum on death before age 75.

Previously, uncrystallised funds would have been tax free up to the LTA, with crystallised funds not tested so completely tax free. After April it won't matter whether lump sum death benefits paid pre-75 came from crystallised and uncrystallised funds; both will count towards the lump sum and death benefit allowance.

Existing Protection?

Various protection regimes will now only serve to increase your tax-free lump sums. Those with fixed or individual protection will have their allowances set to their protected lifetime amounts.

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.

Individuals with enhanced protection will have their LS&DBA set to the value of their uncrystallised as at 5 April 2024, giving those who had valid protection in place at 15 March 2023 and hadn't lost it by 5 April 2023, a further year to increase their LS&DBA.

Individuals with registered PCLS rights under enhanced protection will have their LSA limited to what could have been paid out on 5 April 2023.

Those with enhanced or primary protection and no registered PCLS rights will have their LSA set to £375,000 less lump sums already taken.

If you are unsure what protection you have and what the above means for you please get in touch.

Taxing the Excess

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). Where there is more than one beneficiary, the available allowance will be apportioned between them to determine how much tax each will have to pay.

If the excess lump sum is payable to a non-qualifying entity, such as a trust, it will be subject to basic rate tax. However, if it's paid out more than two years after death or after age 75, the rate of tax due will increase to 45%.

Pre-75 Inherited Drawdown to Be Taxed

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.

It is not believed that those with existing tax free inherited benefits will subsequently become taxable but we await written confirmation on this point.

Comment

Under the current framework, if you die before 75 without touching your Defined Contribution (DC) pension, your beneficiaries can inherit it tax-free, provided it's under the Lifetime Allowance.

Now, the government is mulling over the idea of taxing these pensions if taken as income.

If the inherited pension is taken as a lump sum and falls within the £1,073,100 'Lump Sum and Death Benefit Allowance,' it remains tax-free. Any excess will be taxed as income.

However, if the inherited pension is taken as income, the entire amount could be subject to tax.

This not only confuses beneficiaries but may also push them towards lump sum withdrawals when an income option might better suit their needs.

It could even prompt individuals to access their pensions earlier to spare their loved ones from paying income tax.

This proposed 'death tax' risks sparking political controversy and undermines the simplification gains made by scrapping the Lifetime Allowance.

While the government's communications hint at this new tax, it's not explicitly stated in the draft legislation.

This ambiguity needs urgent clarification so that pension savers can make well-informed decisions.

Plus of course, future governments could still rewrite these rules, adding another layer of uncertainty.