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Last updated: 11 Oct 2023

Pensions Lifetime Allowance removal update – LSA and LSDBA

If enacted, the draft legislation to remove the Lifetime Allowance (LTA) will introduce two new caps on pension benefits from 6 April 2024: a Lump Sum Allowance and a Lump Sum Death Benefit Allowance. Here's what that might mean for the use of pension benefits in future.

Lump Sum Allowance (LSA)

Further clarification is needed in certain areas, but what is clear is that while the removal of the LTA may simplify pension rules, the two new caps need to be carefully considered.

Lump Sum Allowance (LSA)

The LSA introduces a cap on the total amount of tax-free lump sum that an individual can draw from pensions in their lifetime. The maximum tax-free lump sum from a registered pension remains 25% of the benefits, subject to the total cap under the LSA of £268,275 (25% of the current Standard LTA that currently applies of £1,073,100). Any benefits taken from pensions above the LSA will be subject to Income Tax at the individual’s marginal rate.

Individuals with one of the forms of LTA protection, whether that be Primary, Enhanced, or a version of Fixed Protection, will still be able to take a higher tax-free lump sum where the protection remains valid. However, those with Enhanced Protection with percentage-based tax-free cash lump sum rights will be worse off under the new rules, as the lump sum rights have been capped at the amount based on the pension value on 5 April 2023. This means that future investment growth will increase the value of the pension fund, but critically not the tax-free cash lump sum available.

An example of how this will work is shown below:

Bob has Enhanced Protection with 34% protected tax-free cash rights as at A-Day. This means he can take 34% of his pension fund tax free.
On 5 April 2023, Bob’s Self-Invested Personal Pension (SIPP) was worth £3,000,000 and he hadn’t yet taken any benefits from the pension, giving him tax-free cash entitlement on this date of £1,020,000.
If Bob’s SIPP were to grow to £4,000,000, under the old rules he would have been able to take £1,360,000 in tax free cash. However, under the new rules the tax-free cash entitlement is capped at £1,020,000.

This poses the question as to whether individuals with protected percentage-based tax-free cash rights under Enhanced Protection should take this now rather than leave the entitlement within the pension to be drawn in future? Anyone with protected percentage-based tax-free cash rights should consider the need to take advice and consider the alternative options for use of the tax-free lump sum.

About the author

Ben Waters

+44(0)20 7556 1242
watersb@buzzacott.co.uk
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Further clarification is needed in certain areas, but what is clear is that while the removal of the LTA may simplify pension rules, the two new caps need to be carefully considered.

Lump Sum Allowance (LSA)

An example of how this will work is shown below:

Bob has Enhanced Protection with 34% protected tax-free cash rights as at A-Day. This means he can take 34% of his pension fund tax free.
On 5 April 2023, Bob’s Self-Invested Personal Pension (SIPP) was worth £3,000,000 and he hadn’t yet taken any benefits from the pension, giving him tax-free cash entitlement on this date of £1,020,000.
If Bob’s SIPP were to grow to £4,000,000, under the old rules he would have been able to take £1,360,000 in tax free cash. However, under the new rules the tax-free cash entitlement is capped at £1,020,000.

Lump Sums and Death Benefit Allowance (LSDBA)

The new rules have also introduced a second new cap on the tax-free death benefits available from a pension, the LSDBA. This has been set at £1,073,100 and there is no indication the cap will be increased in future.

Where an individual has valid LTA protection under one of the forms of LTA protection mentioned previously, and this remains valid, the LSDBA will be set by the value of their LTA protection. The LSDBA for an individual with Enhanced Protection is expected to be set by the value of their pension benefits on 5 April 2024.

The LSDBA includes the value of any LSA taken by the individual in their lifetime. It is not yet clear how lump sums from pension benefits crystallised prior to 6 April 2024, or pensions in payment before 6 April 2006, will be considered here.

The new cap does not mean an increase in tax payable on pension benefits on death where the pension benefits have not yet been crystallised. This is because prior to 6 April 2023, a 55% LTA tax charge would have applied to the value of any excess uncrystallised funds lump sum death benefit over an individual’s available LTA (or protected LTA). Now that the LTA tax charge has been removed, any excess uncrystallised funds lump sum death benefits will be subject to Income Tax at the beneficiaries’ marginal rate (up to 45%).

The new rules will have a detrimental impact for any individuals who die before age 75, where they have already crystallised their pension benefits. Under the current rules, the value of crystallised pension benefits in drawdown, or flexi-access drawdown, or as a dependant’s annuity, are not tested against the LTA on death and can be passed on to beneficiaries’ completely tax free. However, from 6 April 2024, should an individual pass away before age 75, the value of their pension benefits on death will be tested against the LSDBA and any excess will be taxed at the beneficiaries’ marginal rate of income tax.

Regular pension income left to a spouse, partner, or dependant is not a lump sum death benefit, and will not fall within the LSDBA, and it is not clear how these pensions will be treated under the new rules. As there is no lump sum benefit, it would seem that the benefits will be fully taxable on death. This is much more severe than under current rules where this type of pension can be passed on completely tax free on death where there is a survivor’s pension. Further clarification is needed here.

Inheritance Tax (IHT) treatment

The IHT treatment of pensions has not changed and generally the value of pension benefits will not form part of an individual’s taxable estate and are exempt from IHT. Even with the introduction of the LSDBA, it seems that pensions will remain a valuable tool for estate planning purposes to enable wealth to be passed free of IHT.

Fixed Protection 2016 / Individual Protection 2016

Is there a need to apply for Fixed Protection 2016/Individual Protection 2016?

It is still possible to apply for Fixed Protection 2016 and Individual Protection 2016, and this could be of benefit as these protections will provide a greater LSA and LSDBA. A deadline of 6 April 2025 is currently proposed.

Individuals can apply for Fixed Protection 2016 where they have not incurred a protection cessation event since 6 April 2016. Individual Protection can be applied for where the value of pension benefits on 6 April 2016 was over £1million. Where there is an application for Fixed Protection 2016 after 15 March 2023, for this to remain valid the individual will still be subject to the rules for LTA protection cessation events, meaning that further contributions to money purchase pensions, or relevant accrual within a defined benefit pension scheme from 6 April 2016 will not be possible for the protection to remain valid.

There are also limited circumstances where late applications for the other forms of LTA protection will be considered by HMRC, but these are only in exceptional circumstances.

What should you do?

Perhaps now, more than ever, it is important to review how you might use your pension benefits in future and take advice to ensure that you are well prepared in light of these forthcoming changes.

Buzzacott Financial Planning is authorised and regulated by the Financial Conduct Authority. This article has been prepared to keep readers abreast of current developments. Professional advice should be taken in light of your circumstances before any action is taken or refrained from. The value of investments, and the income from them, may go down as well as up and investors may not get back the amount originally invested.

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For professional pensions advice tailored to your unique circumstances, please fill out the form below and one of our experts will be in touch to discuss your requirements and how we can help.

For more information on the Spring Budget pension rule changes, click here to watch our video.