The Chancellor announced in the Spring budget 2023 that the lifetime allowance (LTA) will be abolished from 6 April 2024. As an interim measure, the upfront LTA charge was removed from 6 April 2023, with benefits above the LTA instead being chargeable to marginal rate income tax when paid.
Draft legislative clauses for the new pensions tax regime have now been published for a technical consultation, which ends on 12 September 2023. In a written statement to Parliament, the Financial Secretary to the Treasury made clear that these are “to seek stakeholder views” and that the “final contents … will be a decision for the Chancellor”.
The draft pension clauses provide detail of the forward-looking regime only, they do not include how benefits taken prior to 6 April 2024 will be dealt with under the new regime (transitional arrangements). Similarly, new reporting and disclosure requirements have yet to be published. Transitioning to a new regime is often the most complex element of any change and if, as intended, the new regime is to be in place by 6 April 2024, all outstanding details are required urgently.
While there will be no restrictions on the amount of income that can be provided, there will be limits (“allowances”) on the total amount of lump sums that can be paid tax-free. Two allowances will exist, both relating to the current level of the LTA, but unless an indexation provision is introduced, inflation will erode their real values significantly.
“Individual’s lump sum allowance” (ILSA) - £268,275 (25% of the current LTA). This focuses on retirement-related lump sums (the pension commencement lump sum (PCLS) and the uncrystallised funds pension lump sum) but also extends to any tax-free element of the various small lump sums.
“Individual’s lump sum and death benefit allowance” (ILSaDBA) - £1,073,100 (the current LTA). As the name suggests, the ILSaDBA will cover any lump sums assessable against the lower ILSA, plus death benefit lump sums (in relation to a member who died under 75). It will also cover serious ill-health lump sums (paid before age 75). Such lump sums within the member’s ILSaDBA will be paid tax-free.
As the amounts to be assessed against the lump sum allowances are solely the tax-free (element of) payments, the value of a pension put into payment will not reduce the scope for a future tax-free lump sum. This also means that PCLS is no longer on a “use it or lose it” basis. For example, under the current regime a member who draws a scheme pension of £50,000 pa (HMRC value £1m), taking no PCLS, would have a scope for a future PCLS of only £18,275 (25% x (£1.0731m – £1m)). Under the new regime, they would still have the full £268,275 available.
Unhelpfully, and a potentially significant complication, the tax-free element of trivial commutation payments, small lump sums, relevant accretions and winding up lump sums must be assessed against, and count towards, the new allowances. These payments are currently excluded from LTA testing (and the concomitant reporting and disclosure requirements) to avoid disproportionate expense when paying small benefits. If these provisions survive, they will be a very unwelcome complication, particularly within GMP equalisation exercises, and would be a retrograde step.
The maximum tax-free lump sum that a scheme can provide will remain as the lower of 25% of the benefit value (subject to any scheme-specific lump sum protection) and the available ILSA. However, this is a restriction solely on the amount that can be paid tax-free. Under the new regime it will be possible to pay a larger PCLS, albeit some of it would be taxable.
Under the current regime a LAELS can be paid where benefits exceed the LTA. With no LTA, the concept of an LAELS falls away. However, as there will be no monetary limit on lump sums, just a limit on how much of a lump sum can be paid tax free, schemes will be permitted to pay lump sums above the available lump sum allowances as authorised benefits. Scheme rules would need to permit this. For example, a defined benefit scheme could offer a PCLS in exchange for pension beyond both existing levels of commutation and the amounts that could have been paid as a LAELS, extending some of the pension freedoms to DB. There is no mention of this, nor of any member protections (such as the advice requirements where the value of a member’s DB entitlement exceeds £30,000 and they wish to transfer DB to DC) within the explanatory notes or accompanying HMRC policy paper. It would be surprising if this relaxation is intentional, in which case the draft legislation may be further refined before the Bill is put before Parliament.
Members with a protected LTA (eg fixed protection) will substitute that higher protected LTA for the ILSaDBA and 25% of that amount for the ILSA. There will be measures to provide scheme-specific lump sums (where a member had an existing protected lump sum of more than 25% of the benefit value on 5 April 2006) in the new regime.
There are changes to the tax treatment of some death benefits:
This tightening of the taxation of assets on death may not be universally supported within the Conservative Party at a time when media headlines have suggested that inheritance tax cuts or abolition are being considered.
Removal of the LTA should ultimately deliver a simpler regime though there are huge challenges in implementing a new regime and some will consider that there is already insufficient time to do so from April 2024. However, there is a general election looming (expected autumn 2024 and required by January 2025) and the pensions tax regime could form a key election battleground; when the government announced these changes, the Labour Party pledged to reverse them. If the new regime is up and running, the government would be able to present this as an example of it delivering on its promises.
The draft legislation published is only a small part of the picture and we expect changes to be made both before the Finance Bill is introduced into Parliament and during its passage. The industry urgently needs details of transitional arrangements and the new reporting/disclosure requirements - these are critical to understanding the new regime and making appropriate changes to processes, systems and communications material. In addition, if changes flow from consultation responses, these too must be communicated without delay.
