When the Chancellor announced that the Lifetime Allowance (LTA) was to be abolished on 5 April 20241, many medics were quick to celebrate the removal of a rule that had caused many a pensions headache, as we have outlined previously.
However, the elimination of the Lifetime Allowance has caused far-reaching implications for retirees and their beneficiaries. Although touted as a measure to simplify pension rules, eradicating LTA carries downsides leaving other limits in place concerning the tax-free lump sum and the amount payable on death from your pensions. The removal of one allowance has given rise to others of arguably greater complexity.
These limitations may influence your decision on the amount you wish to hold in a pension environment.
This article focuses on two of these limitations; The Lump Sum Allowance and the Lump Sum and Death Benefits Allowance.
What is the lifetime allowance (LTA)?
Before 6 April 2024, the LTA was the limit to the total value of pension benefits you could hold without incurring a tax charge. Introduced in 2006, the LTA was initially set at £1.5m, rising to £1.8m before reducing over time to the most present level of £1,073,000. Each time there was a reduction in the LTA anyone with total pension savings in excess of the new limit could apply for protection, either Fixed or Individual. These protections meant you could hold pension savings over the prevailing LTA without incurring additional tax. They were not available to all and had exact requirements before being granted.
What issues does Lifetime allowance abolition cause?
The abolition of the LTA has been generally welcomed. However, one of the primary concerns stemming from its removal is the ongoing effect on pension tax-free lump sums, a vital component of retirement planning for many. Under the previous system, retirees could take a tax-free lump sum from their pension pot, typically up to 25% of its value, within the confines of the LTA.
The chancellor’s recent policy change left behind a cap on the maximum pension tax-free lump sum. This maximum is now known as the ‘Lump Sum Allowance’, but as before the abolition is still limited to 25% of the last LTA set at £1,073,100, or your individual or fixed protection if greater.
Arguably this is more of a ‘rebranding’ than a total change. However, anyone retiring who isn’t aware that the LTA still influences the tax-free element could mistakenly take a greater lump sum than is tax-efficient to access.
For instance, if their pension was valued at £1,600,000 and they took 25% (£400,000) as a lump sum. If they did not hold any LTA protection the maximum that could be accessed tax-free would be £268,250 (25% of the LTA of £1,073,000). In this example, the benefits over the £268,250, i.e. £131,750 would be liable for tax at their marginal tax rate. An expensive mistake to make! Once made, these decisions are irreversible.
An additional concern arises for individuals nearing or exceeding the previous Lifetime Allowance (LTA) limit who are contemplating further pension contributions. If you opt to take your benefits without a tax-free cash component, you might find yourself in a position of merely deferring tax, rather than saving it. This isn’t problematic if you obtain tax relief at a higher rate upon contribution than the rate you’ll face upon withdrawal. However, if your tax rates are similar at both times, you’re essentially, postponing the tax obligation. Moreover, any investment growth will be subject to income tax, which could be disadvantageous. The scenario differs if your employer also contributes to your pension, as their contributions can offset the tax liability, providing a net benefit.
The removal of the LTA and its implications on Inheritance tax
The removal of the LTA exacerbates the issue of inheritance taxation on pension funds. Inheritance tax (IHT) rules dictate that upon the death of the pension holder, their remaining pension pot may be subject to taxation if it exceeds certain thresholds. With the LTA removed and with large LTA tax charges that reduce the fund value no longer being charged, fund values may be higher. Also, the lack of LTA may incentivise increased contributions to pensions. Both actions would increase the likelihood of pension funds surpassing IHT thresholds, leading to greater tax liabilities for beneficiaries. This limit set by the Chancellor is now known as a ‘Lump Sum and Death Benefit Allowance’, set at the rather familiar figure of £1,073,100. Importantly, this factors in both the tax-free lump sum someone takes while alive in addition to any lump sums paid on death2.
The complexities surrounding inheritance taxation on pensions can be particularly burdensome for families already grappling with the loss of a loved one but also risks eroding the value of the inheritance intended for family members.
For more details on this subject please see the government guidance: Lifetime allowance guidance newsletter: February 2024 – GOV.UK (www.gov.uk)
And it’s not over yet…
The recent changes to the Lifetime Allowance (LTA) required swift implementation to align with the Chancellor’s deadline of April 6, 2024. In response, HMRC issued guidance on April 4, 2024, advising certain individuals to postpone accessing pension benefits due to pending corrections in the legislation.
This advice is particularly pertinent for those with enhanced and primary protection holding protected lump sum rights exceeding £375,000, or those due to receive lump sum death benefits from funds crystallised before April 6, 2024, among other specific cases.
It is recommended to heed this guidance and delay action until the legislation is clarified. For comprehensive information, refer to HMRC’s Newsletter 158.
Let’s summarise
The abolition of the lifetime allowance aimed to simplify pension regulations, yet its effects continue to unfold. For those uncertain about their current position, consulting with a specialist advisor is prudent so you can effectively navigate these ongoing developments.
The lifetime allowance may be gone, but it is very much still an influence! If you need further assistance with your pension or understanding the transitional tax-free amount certificate, feel free to contact one of our specialist financial advisers.
Please remember tax and the suitability of pensions and investments are dependent on your own circumstances and personal situation and are subject to changes based on UK legislation and taxation regime. This article is based on our understanding of current legislation.
1Govt confirms lifetime allowance abolished from April – FTAdviser
2Lifetime allowance guidance newsletter: February 2024 – GOV.UK (www.gov.uk)
I took my pension from the nhs in February 2013 and had fixed protection on the pot. Now that the lifetime allowance has been removed can I start contributing again to a pension. I’m now 71 years old.
Hi there,
You can contribute to a pension and receive basic rate tax relief on the contribution up to the age of 75. The maximum contribution on which you can claim relief is £3600. You can still contribute to a pension beyond 75 but won’t receive tax relief. Contributions beyond the age of 75 should be a “reasonable” amount:
“If HMRC consider the purpose of an excessive/large contribution to be to remove assets from your estate it is possible that the value of the contribution may be subject to inheritance tax and this may depend on your health at the time the contributions are made”
There is no cap on the contribution beyond the age of 75, but one needs to think about the future beneficiaries of the pension and whether it would be better to make gifts out of income, for instance, as a way of avoiding future IHT issues.
I hope this helps.
Best wishes, Owen