The Lifetime Allowance (LTA) was introduced over fifteen years ago, setting the maximum amount of pension savings that an individual could contribute to registered pension schemes before their savings would be subject to a tax charge.
As part of efforts to incentivise those who have retired or are planning to retire to return to work and boost the economy, the government has abolished this allowance – meaning workers can save more into their pensions without triggering the tax charge.
Though the LTA was scrapped in April this year, further changes were needed to support its removal and facilitate the taxing of lump sums and death benefits without it.
To this end, draft legislation and an accompanying policy paper have been published to set out the changes due to take effect from 6th April 2024. These include the introduction of a new lump sum allowance and death benefit allowance.
If the legislation is enacted, these will be the same as the previous LTA – which was frozen at £1,073,100 in 2020. There will also be significant changes to the taxing of death benefits when a pension saver passes away before they turn 75 years old.
Here is what we can learn from the policy document and how abolishing the LTA could affect the future of pension planning for many savers.
Lump sum death benefits
A beneficiary can typically receive tax-free lump sum death benefits if the deceased saver did not access the pension yet (known as uncrystallised benefits).
While the LTA has been removed, there will still be a cap to limit the amount that can be taken as a tax-free lump sum – which is set at the same level as the LTA.
The allowance is combined for tax-free lump sums and death benefits, meaning the amount available for a lump sum death benefit would be reduced by any tax-free lump sums the pension saver may have taken during their lifetime.
Before the LTA was scrapped, any excess over the £1,073,100
cap would be taxed at a high rate (55%). From next April, excess will be taxed at the beneficiary’s marginal tax rate. This means their Income Tax
rate will apply, which is likely to be much lower.
Whether lump sum death benefits were paid from crystallised or uncrystallised funds will no longer matter, as both count towards the lump sum allowance.
When there is more than one beneficiary, the allowance will be allocated between them to determine each beneficiary’s tax liability.
Income death benefits
The policy paper also proposes a new approach to taxing uncrystallised death benefits taken as income, either from a drawdown fund or annuity, which was not announced with the initial news about abolishing the LTA.
Previously, pension income was exempt from tax, as a drawdown arrangement would be a ‘benefit crystallisation event’ under the LTA, and the charge would not apply to funds received by beneficiaries within two years of the saver’s death under 75.
Now, it seems that withdrawals from a drawdown scheme inherited from a saver who passes away before 75 will no longer be tax-free from next April, with such pension income also becoming taxable at the beneficiary’s marginal tax rate.
As lump sums taken from the same uncrystallised funds would be completely tax-free if the amount was lower than the lump sum and death benefit allowance, this could push beneficiaries into choosing to take a lump sum even if income would have been a more suitable option for their needs.
We will have to await further information to find out whether this will also apply to death benefits from crystallised pension funds.
How will this affect your pension?
The policy paper on abolishing the lifetime allowance is available to read on the government website. As the legislation is still in the draft stages, further changes may be made before it is implemented in 2024 to 2025.
It will be essential for anyone who may be affected, including savers and their potential beneficiaries, to keep up with the latest developments as the legislation is finalised. Reviewing individual pension plans and protection levels is vital.
Regardless of the level of your pension funds, it’s a good idea to consult with a financial advisor to make informed decisions about what’s best for your retirement plans and for your beneficiaries in the event of your death.
If you would like to get ahead and maximise your pension planning, get in touch with gbac to discuss your options with our accountants in Barnsley.
You can call us on 01226 298 298 or email info@gbac.co.uk to get started.