In his 2023 Spring Budget, the Chancellor of the Exchequer, Jeremy Hunt, announced the abolition of the Lifetime Allowance (LTA). But what exactly are the changes, and what do they mean for your pension planning? Read more in this article.
The background
In March 2023, the government announced that the Lifetime Allowance (LTA) was to be abolished.
Historically, those at the higher end of the pay scale would have been impacted by the LTA – in other words, the total amount you can build up in all your pension plans over your lifetime without incurring an extra tax charge.
The limit (£1,073,100) applied to the value of all pensions you belong to, meaning you could face an extra charge on top of the usual income tax.
However, from April 2024, the LTA will be officially removed from the statute books and replaced with new allowances.
Tax treatment depends on your individual circumstances and may be subject to change in the future.
What are the new allowances?
The Lifetime Allowance has been replaced by three new allowances.
These are:
- The Lump Sum Allowance (LSA)
- The Lump Sum and Death Benefits Allowance (LSDBA)
- The Overseas Transfer Allowance (OTA)
From April 2024, only the non-taxable portions of lump sums will be tested against certain limits. Benefits that exceed these limits will be taxed at marginal rate upon death before the age of 75.
After the age of 75, benefits will become taxable, unless they are taken as income from a beneficiary flexi-access drawdown (BFAD). If this is the case, the benefits will still be tax-free.
We’ll delve into these new allowances in more detail below, but it’s also important to note that if you’re applying for fixed protection 2016 or individual protection 2016, there is a deadline of 5 April 2025.
Lump Sum Allowance (LSA)
The standard Lump Sum Allowance (LSA) will be £268,275. As it currently stands, this figure will not increase. If you have LTA protections, your LSA will be based on your protected LTA.
Your LSA may be reduced based on any Relevant Benefit Crystallisation Events (RBCEs) that occur or have already occurred.
An RBCE (previously known as tax-free cash) generally refers to any lump sum benefits that you have previously taken, including:
- A pension commencement lump sum (PCLS)
- An uncrystallised funds pension lump sum (UFPLS)
- A stand-alone lump sum (SALS)
Only the non-taxable portion of the above lump sums are deducted from the allowance. For more information on deductions, see the table below.
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Lump sum
|
Deduction
|
|---|---|
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A standard PCLS
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The whole amount of the lump sum is deducted.
|
|
A PCLS paid with scheme specific lump sum protection
|
25% of the amount crystallised is deducted.
|
|
An UFPLS
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The deduction applies to the non-taxable amount of the lump sum.
For example, if £100,000 UFPLS is taken and £25,000 of that was non-taxable, £25,000 of the LSA is used up.
|
|
A stand-alone lump sum (SALS)
|
25% of the lump sum that is paid is deducted, unless you have a Primary or Enhanced Protection.
If this is the case, the deduction is 100% of the lump sum that is paid.
|
It’s also worth noting here that Small Pot Payments don’t use up the LSA.
Lump Sum and Death Benefits Allowance
The standard Lump Sum and Death Benefits Allowance (LSDBA) will be £1,073,100. As with the LSA, there are currently no plans to increase this figure.
If you have LTA protections under the old rule, your LDSBA will be based on your protected LTA. If you have enhanced protection, your LSDBA will be set at the value of benefits that could have been taken on 5 April 2024.
Your LSDBA will be reduced based on any RBCEs that occur or have occurred. However, the deductions that reduce LSDBA are wider than those that reduce LSA. To find out more about these deductions, or how they might affect you, speak to your Specialist Financial Adviser from Wesleyan Financial Services.
Like the LSA, Small Pot Payments don’t use up any of the LSDA. Charity Lump Sum Death Benefits are also excluded, as well as Trivial Commutation Lump Sum Death Benefits.
Overseas Transfer Allowance (OTA)
The Overseas Transfer Allowance will be set at the same level as your LSDBA. If you transfer funds to a Qualifying Recognised Overseas Pension Scheme (QROPS), it will be tested against the OTA.
Any amount exceeding the allowance will incur a 25% overseas transfer charge. This transfer doesn’t affect LSA or LSDBA, and neither do the benefits received overseas.
To learn more about the OTA, see the latest government draft legislation on the abolition of the Lifetime Allowance.
Transitional Allowance usage
When it comes to accounting for previously used LTA against the new allowances, a standard calculation will be used. This is based on the portion of the Lifetime Allowance that you’ve already used up.
The LSA is reduced by 25% of the amount previously used. This means that if 100% of the LTA was used, the LSA is zero. If 50% of the LTA was used, the calculation would be as follows:
- 50% x £1,073,100 x 25% = £134,137.50
There is a similar deduction when it comes to the LSDBA. However, where some or all of the previously used amount is in respect of a Serious Ill-Health Lump Sum, the amount deducted is 100% of the SIHLS (rather than 25%).
Transitional tax-free amount certificates
The calculation above provides a standard reduction amount, which is 25% of the amount of LTA previously crystallised.
However, if the actual tax-free amount you get is less than the standard reduction, you can apply for a transitional tax-free amount certificate. This must be done before your first RBCE after April 2024.
You can apply for one of these certificates through any pension scheme you are a member of, but it’s advisable to choose the provider you wish to take the first tax-free amount from.
A transitional tax-free amount certificate is used to prove that you are entitled to a lower reduction in your LSA than that provided for by the standard default calculation.
The certificate also allows you to have your previously taken tax-free cash recorded as cash actually received, rather than 25% of the total benefits crystallised. This may be of benefit if you have received less than the minimum LSA of £268,275, but have used up all of the previous LTA.
There are a few things to be aware of before applying, including:
- The certificate must be applied for by you. If you pass away, it can be applied for by your personal representatives
- The certificate must be made prior to the first RBCE after April 2024
- You can apply for the certificate through any pension scheme you are a member of (or were immediately prior to your death). However, it’s intended that you apply via the provider you want to take the first tax-free amount from
- You must supply evidence of previous amounts paid when you make your application
When you make your application, your pension provider has up to three months to supply your certificate (or to state why they refuse to issue one).
It’s also important not to apply for a certificate without being certain that you will benefit from it. This is why it’s wise to seek advice from your Specialist Financial Adviser from Wesleyan Financial Services before you take any action.
Worried about changes to the Lifetime Allowance?
Understanding changes to the Lifetime Allowance can be complex, which is why it’s important to speak to your Specialist Financial Adviser from Wesleyan Financial Services if you’re concerned.
They’ll help you review your pension and make sure you’re on track to meet your retirement goals in the most tax-efficient way.