LTA - The final chapter?

In the pension world I think it’s fair to say that the Lifetime Allowance has dominated most people’s thoughts so far this year.

The chancellor announced in the Spring Budget that he wasn’t raising the limit to £1.8million, as had been widely rumoured the weekend before, but he pulled a rabbit out his hat with the announcement that he was abolishing the LTA completely.

It wasn’t that straightforward though!

This was going to happen in two stages. In stage one, the LTA had not actually been abolished – it was still fully operational. What did happen though was the LTA charges were set at 0% and in their stead the lump sum rules were tweaked so that the tax charge when you were over the limit was marginal rate as opposed to the previous 25% and 55%. 

Death benefits taken in pension form, beneficiary annuity or drawdown, pre age 75 and within 2 years of the scheme becoming aware of the members death were completely tax free which seemed overly generous. HMRC did however confirm that was the case – no tax at all regardless of how much went into drawdown. Only lump sum benefits over the LTA would be taxed.

The policy objective was to prevent pension tax charges from making people (the headlines were on the NHS) retire early and / or not re-enter the workforce because of the “penal“ pension tax charges. To this end the rules were also amended for those who held Enhanced or one of the Fixed Protections. These people were prohibited from any further pension accrual, at pain of losing their protected allowances. But new rules were introduced meaning as long as you had applied for your protection prior to the Spring Budget then you could not lose it on or after 6 April 2023. Those who may still be looking to secure Fixed and Individual Protection 2016 now have a deadline of 5^th April 2025 to apply.

Fairly straightforward, certainly based on what was to come, and all legislated for in the summer when Finance (No2) Act 2023 was laid.

Minds then moved to the actual abolishing of the allowance which was to happen at a future fiscal event.  A policy paper was duly issued with draft legislation for consultation in July. A bit of a furore ensued with the policy statement stating that death benefits in income form would be fully taxed going forward - more on that later. This was quickly deemed incorrect, and the treatment was TBC.

The consultation showed us the direction of travel, and this was that in future only the tax free amount of lump sum payments would get tested and it would be against two new allowances. These were the Lump Sum Allowance LSA and the Lump Sum and Death Benefit Allowance LSDBA. They were fixed amounts, with no provision to increase within the rules, of £268,275 and £1,073,100 respectively. If you had LTA protections, then you could get higher allowances moving forward.

Very broadly speaking, the monetary amount of benefits you could receive after LTA abolishment were much the same as before – just with a whole new set of language describing how you got to what was in effect the same number! 

As with all consultations there were many questions that went unanswered. There was still not any real certainty of what the future rules would look like to at least start preparing clients for their retirement planning post April 2024. There were many points of detail and niche areas where more information was required but there were three main areas where some clarity would allow us to move forward.  Namely, how benefits taken prior to April 2024 would affect the new allowances, what would happen with death benefits and what would happen to transfers overseas. 

The recent Autumn Statement and subsequent Finance Bill, whilst still leaving us requiring clarity in certain areas, answers a lot of the outstanding questions. Crucially, it does give us a really good idea of the impacts on retirement planning going forward in those three key areas.

Transition from LTA to LSA/LSDBA

The new allowances will be reduced by the tax free amount of lump sums going forward. These are shown in the table below -

That is the new rules for those who have not previously taken benefit. For those who have then the benefits already taken are also deducted. Two things need taken into account benefits taken prior to 6 April 2006 i.e. pre commencement pensions and benefits taken between then and 5 April 2024.

The latter is relatively straightforward.  For the LSA 25% of the LTA used is deducted. For LSDBA it is 100% of any serious ill health lump sum and 25% for other lump sum. If you used 100% of LTA previously you do not get any of the new allowances.

As an example:

Bob has used up 46.59% of the lifetime allowance (£500,000)

£500,000 x 25% = £125,000

So his LSA is £268,275 - £125,000 = £143,275.

But there is a twist in the tale – the “default calculation” above can be overridden. If Bob can prove that his previous PCLS and tax free amounts of an UFPLS were less than the £125,000 then he can get a lower deduction. This is done by asking the relevant schemes that paid his benefits for a “transitional tax free amount certificate”. If you have always taken full tax free cash then there is no benefit in asking for one as your default amount should be correct.

If Bob had used that £500,000 going into drawdown and taking his full tax free cash entitlement, then he would have a £125,000 reduction. However, if that was instead a full scheme pension with no tax free amount paid then he could keep the full LSA.  

As per the draft Bill, these certificates must be asked for prior to any benefits being taken after April 24. So anyone phasing currently, with a benefit payment due early in the tax year, may have to pause benefits until any certificate is requested. 

Clarity is required on pre commencement pensions. It appears that the default calculation applies, if they were tested against the LTA, with the ability to prove a lower amount. This lower amount will be £0 as they will not have been able to take PCLS or an UFPLS as these did not exist prior to 6 April 2006. Where there has been no LTA test then the default applies with no option to prove a lower amount. This seems anomalous but if that is how it is to be then there may be merit in triggering a BCE prior to 6 April 2024 if you have an untested pre commencement pension and still have benefits you have yet to take.

Death Benefits

Only lump sum death benefits will be tested going forward. Age 75 and the 2 year window are still key as they will drive the taxation treatment, as they do now.

 A key change from today’s rules is that lump sum death benefits paid from crystallised pots will be tested against the LSDBA where previously there was no LTA test. This applies to lump sums paid from member and, some might say controversially, beneficiary drawdown pots. In the new world where only the PCLS was tested entering drawdown then there is logic in testing lump sums paid form the drawdown pot.

The bill does confirm that any pension funds used to purchase a beneficiary income option will not be tested against the LSDBA and if paid within 2 years of the scheme being aware of the members death and before 75 will be completely tax free (like now). Rumours as to the demise of inherited pensions are unfounded. Likewise, beneficiary incomes in payment as at 6^th April 2024 will be taxed as they currently are.

Lump sums form pots crystallised prior to April 2024 will not be tested against the LSDBA. This means schemes will need to keep drawdown designation pre and post April 2024 separately (or at least be able to account for that part of the drawdown that is LSDBA exempt and that part that is not).

You may will think then that it is a good idea to put all your money into drawdown prior to the new rules to secure the LSDBA exemption. This has disadvantages in that it would mean taking all your tax free cash in one go, exposing it to IHT perhaps and/or removing the flexibility and tax efficiency afforded by taking your tax free amount in a phased manner. You would probably have a less tax efficient place to invest it too.

I think the key thing to do is ensure your client’s pension scheme allows the beneficiary income options and ensuring nominations are suitable for allowing the flexibility of drawdown. This way you could designate to beneficiary drawdown without an LSDBA test and then afterwards take an 100% income payment that would be tax free (pre 75 < 2yrs).

If the death benefit is going to be taxable then the drawdown options is still key for an efficient extraction as opposed to everything paid being taxable in the one tax year.

Overseas Transfers

There has been another allowance created to deal with transfers to a QROPS. It is called the Overseas Transfer Allowance and is set at the value of the individuals LSDBA. 

Unsurprisingly, it is used up by transfers overseas to QROPS that do not otherwise suffer an overseas transfer charge.

If the limit is breached the excess is taxed at 25%. But unlike the current BCE 8, that uses up Lifetime Allowance, an overseas transfer from 6^th April 2024 will not use up LSA and LSDBA.

It also appears that the overseas scheme will be able to pay 25% tax free cash as normal. To all intents and purposes this means you can get tax free allowances twice – once from the overseas scheme and once from your UK schemes. It seems too good to be true but that’s where we are at present and that does seem to be the intent.

The Final Chapter?

There are points of detail that need ironed out and some clarity required in other areas. Government have reserved powers to make changes to the rule up until April 2026.

We now know the policy intent and direction of travel. It's unusual for a Bill to materially change going through parliament  and I would expect the Bill only to receive tweaks to ensure it delivers the policy intent. I guess you can never say never but I suspect the final direction of travel is pretty much set.  

It looks like we now know what the advice world needed to know to allow us to move forward in preparing most clients for 6^th April 2024 and beyond.