IFA column: The Lifetime Allowance – what next?

There are three things I want to help you to take away from this latest IFA column:

• The basics of the Lifetime Allowance (LTA)
• What LTA Protections are and why they are still relevant
• What the new Lump Sum Allowance (LSA) system looks like

It was difficult to miss the attention-grabbing headline from the March 2023 Budget, when the Chancellor announced that the Lifetime Allowance will be scrapped. Over the months that have followed, we have gradually been drip-fed the details behind this policy and it is safe to say that all is not as simple as that March headline made out.

What is the Lifetime Allowance?

The LTA was introduced in April 2006 and caps the total amount a person can have in a pension without having to pay an “excess funds” tax charge. Where tax-free cash is taken from a pension, this is capped at 25% of the fund value, subject to a maximum of 25% of the relevant LTA. The LTA therefore limits both the amount of income and the amount of tax-free lump sum that can be taken from a pension. Up until 6 April 2023, anything taken over the LTA was subject to a tax charge of 55% if taken as a lump sum or 25% if taken as income (which was then also subject to income tax, the general outcome being broadly similar to that of taking the excess as a lump sum).

Originally, the LTA was set at £1.5m. It has moved up and down since, with a peak of £1.8m and a low of £1m. The current level of £1,073,100 has been in place since the 2020/21 tax year.

What is LTA Protection?

Each time the LTA was reduced, there was a Protection regime that meant you could apply to retain a higher LTA, subject to certain criteria.

The full detail of the Protection system is too complicated to go into in this article, but it is useful to be aware of the types of Protection that you may find clients hold, namely:

• Enhanced
• Primary
• Individual 2014 or 2016
• Fixed 2012, 2014 or 2016

Under the old system, holding one of these protections gave you a higher amount that you could have in your pension, before you were subject to an excess funds tax charge.

For example, Fixed Protection 2014 gave LTA Protection of £1.5m, meaning tax-free cash was protected at £375,000, being 25% of that amount.

Although the LTA has “been scrapped” and the system is changing, LTA Protections are still relevant under the new system for calculating:

• Maximum Tax-Free Cash (which will now be known as a Lump Sum Allowance)
• Maximum Lump Sum that can be paid out on death (which will now be known as a Lump Sum and Death Benefit Allowance)

The table below shows the limits for Fixed and Individual Protection. These are the same under the new system as they were under the old one.

The details for Primary and Enhanced Protection are a little more complicated and tend to vary due to individual circumstances. Please seek advice for further details on these.

Primary Protection and Individual Protection have always allowed additional pension contributions to be made without losing the protections. If Enhanced Protection or any of the Fixed Protections were held on 15 March 2023, it is now possible (from 6 April 2023) to also make contributions without losing these protections.

So, what does the new system look like?

From 6 April 2024, the LTA will be replaced with a new regime. The difference is that under the new system, the government is only interested in testing your pension when a lump sum is paid out. This might be Tax-Free Cash (Pension Commencement Lump Sum) or it might be a lump sum paid out on death.

As mentioned above, there will be two main allowances:

• Lump Sum Allowance (LSA)
• Lump Sum and Death Benefit Allowance (LSDBA)

If you do not hold any LTA Protection, then the limits are as follows:

You will notice that these limits are the same as those currently in place under the Lifetime Allowance. If you go over these limits, any excess will be taxed as income.

There is a crucial distinction between lump sum and income in the new system. Income is not tested but lump sums are.

Where the pension member dies, the principle of only lump sums being tested continues with any excess subject to income tax on the recipient.

Under the new system, it is therefore really important for anyone affected by the limits to ensure that their pension has the option to pay out death benefits as income rather than a lump sum. This is usually done through the option of beneficiary drawdown. If death benefits are taken from the pension after it has been designated to beneficiary drawdown, it is classed as “income”, not a lump sum and will not be subject to limits or tested. It is worth noting that adult children are not generally considered as dependents and must therefore be specifically nominated as a potential beneficiary to be able to keep the pension tax wrapper and move into drawdown.

As you will appreciate, this article cannot cover all of the intricacies of the new system, but hopefully gives you a flavour of what is to come. As always, it is important to seek personalised advice for any individual cases – we have a great community of Financial Planners in the Resolution family, who are particularly specialised in helping with Pension and Divorce work. Please feel free to look any of us up if you would like more detailed information on the new LSA and LSBDA system.

cheryl@bowdenfinancial.com