As we have covered previously, in the Spring Budget 2023, the Chancellor Jeremy Hunt announced that he would abolish the Lifetime Allowance (LTA) to encourage individuals to return to work, particularly those aged 50 and above. Initially, it was not clear how this would be replaced or even reinstated, although there is now some clarity.
Indeed, many NHS Doctors welcomed the changes, confirmed in the Finance (no.2) Bill, which helped remove incentives to reduce working hours, or even to leave the labour market completely, due to limits on pension tax-relief.
As of 6 April 2024, the allowance was therefore totally abolished and replaced with the new allowances covered later. So, how does this impact pension savers, why did Labour want to re-introduce the allowance, and what has it been replaced with?
Background
The LTA was introduced on 6 April 2006 and limited what an individual could save into their pension before a tax charge applied. The LTA did not remain static having changed over the years, initially beginning at £1,500,000 and ending at £1,073,100. Individuals were also able to apply for Lifetime Allowance protection with the aim of preventing those with large pension savings from being disadvantaged as the allowance reduced over the years.
| Tax Year | Standard Lifetime Allowance |
| 2023/24 | £1,073,100 |
| 2019/20 | £1,055,000 |
| 2018/19 | £1,030,000 |
| 2017/18 | £1,000,000 |
| 2015/16 | £1,250,000 |
| 2013/14 | £1,500,000 |
| 2011/12 | £1,800,000 |
| 2009/10 | £1,750,000 |
| 2008/09 | £1,650,000 |
| 2007/08 | £1,600,000 |
| 2006/07 | £1,500,000 |
Figure 1. Changes to the Lifetime Allowance since April 2006.
Where benefits exceeded the allowances, any excess over the LTA, if taken as a lump sum was previously charged at 55%. Alternatively, the fund could be used to provide an income, and in that scenario, the excess was taxed at 25%. The latter would also be taxable at the individual’s marginal rate of income tax, meaning the rates for a basic rate taxpayer were broadly similar. In comparison to the current position, those rules provide much less of a savings incentive for individuals with sizeable pension benefits that are close to, or who have exceeded the LTA.
So, why did Labour want to reintroduce this? Well, in short, a new government might look at the tax treatment of pensions to provide tax receipts that can contribute towards a funding gap that seems set to widen, targeting an area which has historically been seen as generous to high earners and by virtue, many conservative voters. However, for many, Labour’s apparent decision not to reintroduce the allowance is welcome news.
But what has the LTA been replaced with?
Whilst the LTA in its previous form was abolished entirely, this did not change everything. The rules around the calculation of the annual allowance remain unchanged for example, though the LTA has however been replaced by three new allowances:
- The Lump Sum Allowance (LSA) £268,275
- The Lump Sum Death Benefits Allowance (LSDBA) £1,073,100
- The Overseas Transfers Allowance (OTA) £1,073,100
The LSA and the LSDBA are both allowances which limit the amount of tax-free benefit that can be paid, whereas a check is made against the OTA when benefits are transferred overseas. It is worth noting that these allowances may be higher if an individual has LTA protection, and they will be reduced if a proportion of the LTA has already been used. You may note that the allowances are based on the total LTA as a 5 April 2024, with the LSA representing 25% of the standard LTA at that date.
The Lump Sum Allowance (LSA)
This allowance applies when tax-free benefits are taken, with any amount of Pension Commencement Lump Sum (PCLS), or more commonly known as tax-free cash, is taken. It is effectively a limit on the amount of tax-free cash that can be drawn from the pension, with the monetary amount taken being deducted from the allowance.
The Lump Sum Death Benefits Allowance (LSDBA)
This allowance again applies when tax-free benefits are taken. It is the maximum amount of tax-free lump sum that can be paid to your beneficiaries when you die before age 75. Any amount above the limit will be taxed at the beneficiary’s marginal rate. After age 75, regardless of the remaining LSDA, all the benefits will be taxed at the beneficiaries’ marginal rate of tax.
The Overseas Transfer Allowance
Any transfer to a Qualifying Recognised Overseas Pension Scheme (QROPS) is now tested against the OTA, less the amount equal to 100% of your Lifetime Allowance used when the LTA was abolished.
Transitional Tax-Free Cash Certificates
Changes to the LTA therefore have led to the introduction of Transitional Tax-Free Cash Certificates, which can provide confirmation of the individual’s remaining LSA and LSDBA taking into consideration any previous tests against the previous LTA. As part of the abolition, any previous benefits that have been crystallised must be converted into the remaining LSAs and LSDAs.
It is therefore important to identify those who are impacted, as not administering this correctly could potentially result in a loss of benefit entitlement.
Who needs to apply?
A large majority of savers will not need to apply for a Transitional Tax-Free Cash Certificate, largely if you are not close to or are unlikely to come close to using these allowances. The first thing is however to consider the total amount of tax-free cash received before the abolition of the LTA and whether this is less than 25% of the percentage of the LTA used on 5 April 2024 multiplied by £1,073,100.
Remember, where 100% of the LTA has been used on 5 April 2024, the above allowances are automatically set to zero and where the individual has LTA protection the limits will be higher. For example, for someone with Fixed Protection 2014 the LSDBA would be set to £1,500,000 and the LSA would be £375,000.
Summary
The changes ensure that there is still a mechanism in place to limit the amount of tax-relief for people with sizeable pension benefits, however there is now a greater incentive for individuals to continue to save into pensions, which helps address wider issues, including re-incentivising individuals such as doctors to continue to work.
Considering previous changes to pension legislation, such as A-Day 2006, which saw sweeping changes to workplace and personal pensions. The abolition of the Lifetime Allowance, while hugely significant, will not impact pension savers in the same way. Overall, the change does make pensions more attractive, and following Labour’s statement to say they will not reintroduce the allowance, there is much appreciated clarity in terms of understanding how people can save for the future, with much less uncertainty around any potential sweeping changes to complex rules in the short-term.
As always, if you have any questions or wish to discuss any of the topics covered, please contact your Financial Planner who will be more than happy to assist.
