Proposals – removal of LTA and introduction of two new lump sum allowances
The LTA removal will involve the following key proposed changes.
Proposal 1: Removal of LTA
There will no longer be a LTA which limits pension savings on and from 6 April 2024 – pension benefits will just be subject to income tax. It also means that it will no longer be necessary to have available LTA to take lump sum payments.
Instead, a new tax regime for lump sums and LSDBs will apply with the introduction of two new allowances: a new ‘lump sum and death benefit allowance’ of £1.073m, and a new ‘lump sum allowance’ of £268,275.
These two allowances signify new maximum lump sum amounts above which marginal rate income tax will be applied. The proposal is that that there will be “no limit on the size of authorised lump sums and lump sum death benefits, only a limit on the amounts not subject to income tax”. Regular pension income is not going to be included within the allowance tests.
Proposal 2: Lump sums and LSDBs – two new allowances
New ‘lump sum and death benefit allowance’ of £1.073m: Following removal of the LTA, certain authorised lump sums and LSDBs will not attract a tax charge where the lump sum does not exceed £1.073m (the current standard LTA). Payments above this level will be subject to income tax at the recipient’s marginal rate. The new limit is a personal limit – it is a test of the total value of lump sums paid and will apply across all registered pension schemes for all lump sums and LSDBs.
New ‘lump sum allowance’ of £268,275: The maximum tax-free limit for a PCLS (and UFPLS) will remain frozen at £268,275, other than for individuals with existing protections in place that entitle them to take a higher lump sum. Other lump sums such as trivial commutation and winding up lump sums will also be assessed against this allowance. Payments above this level will be subject to income tax at the recipient’s marginal rate. This new allowance will sit under the overall £1.073m.
This could represent a significant change for DB schemes because the draft legislation as it currently stands seems to allow a higher PCLS to be paid than is presently the case. Of course, any right to a higher PCLS would depend on a scheme’s rules allowing this – an entitlement to a higher PCLS is not an automatic right. Furthermore, HMRC’s Newsletter 152, which discusses the proposed changes, recognises the potential impact of this and asks for views on whether restrictions should be introduced for the PCLS going forward to prevent ‘unforeseen circumstances’ as it is not the Government’s intention to “significantly expand pension freedoms”.
LSDBs where a member dies under age 75: the LSDB will count towards the deceased member’s lump sum tax free limit with the excess to be taxed.
Proposal 3: Death of a DC member before age 75 with uncrystallised funds
At present, if a member with DC benefits dies under age 75 and has uncrystallised funds, these can be provided to a beneficiary through drawdown or an annuity without a charge to income tax. Although the draft legislation does not alter this, the policy paper notes that paying unused death benefits as an UFPLS or an annuity will incur income tax indicating a change in policy. HMRC welcomes feedback on this area.
Proposal 4: Protections and lump sum protections
The policy paper notes the intention is that those with valid lump sum and LTA protections keep their rights to higher levels of tax-free lump sums and, where applicable, higher tax-free parts of lump sums.
Individuals will have until 5 April 2025 to apply for fixed protection 2016 and individual protection 2016 – these protections were made available when the LTA was reduced in April 2016.
Certain restrictions for individuals with valid enhanced protection and a protected pension age below 50 will be introduced.
Members with enhanced protection, fixed protections 2014 and 2016 were subject to benefit accrual restrictions – the Finance (No. 2) Act 2023 removed these restrictions where a valid application was made for the protection before 15 March 2023.
Proposal 5: Removal of certain BCEs and charges
The removal of the LTA means that most BCEs will no longer need to be checked against the available LTA and can also be removed as a BCE. The BCEs being removed include those relating to taking a pension and where there are unused pension funds at age 75 or upon death. BCEs relating to the payment of relevant lump sums and LSDBs will remain because they need to be tested against the new lump sum allowances with payments above the limits triggering a charge to income tax – these will be classed as ‘relevant BCEs’ in the legislation.