All change for the Lifetime Allowance from 6 April 2024?

Penny Cogher and Harriet Fletcher from Irwin Mitchell's Pensions team explain how the Finance Act 2024 affects pensions tax.

Key points

On 15 March 2023 (Budget Day), the Government announced the abolition of the lifetime allowance from 6 April 2024 and as a precursor, the removal of the lifetime allowance tax charge from 6 April 2023 onwards.

This has created two different pension tax regimes:

• The New Regime, created by Finance Act 2024 – for pension taxation events that occur from 6 April 2024.
• The Old Regime, with the lifetime allowance, created by Finance Act 2004 - for pension taxation events that occur before 6 April 2024.
  • The default position will be an assumption that maximum tax-free cash has been taken with pension entitlements.

The Old Regime will continue to be relevant for exercises conducted after 6 April 2024 but which are intended to have retrospective effect pre-6 April 2024, for example, GMP equalisation.

Transitional calculations apply where an individual straddles both Regimes – i.e., has taken some benefits before 6 April 2024 but has not yet used up all of their lifetime allowance. For these:

• In most circumstances, the allowances will be reduced by 25% of the lifetime allowance already used by the individual.
• The lifetime allowance is reduced to zero in 2 specific situations where payment has been made 6 April 2024:
  • Payment of a serious ill-health lump sum to an individual aged under 75.
  • Payment of a lump sum death benefit where the individual died aged under 75.

Where there is clear evidence of the lump sums an individual scheme member has previously taken, that person can ask their scheme(s) to certify their personal “transitional tax-free amount”. Personal representatives can also do this, after a scheme member’s death. The scheme has 3 months to give the certificate or refuse the application. 

The New Regime from 6 April 2024 in detail

The Finance Act 2024 creates a new regime for the taxation of lump sums. Pension income will continue to be taxed through the framework of the Income Tax (Earnings and Pensions) Act 2003.

However, there are 3 new allowances:

1. Lump Sum Allowance – LSA - a fixed limit of £268,275 (25% of the current lifetime allowance) on the tax-free cash that can be paid to a person as pension commencement lump sums (PCLS) and as the tax-free part of uncrystallised funds pension lump sums (UFPLS).
2. Lump Sum and Death Benefit Allowance- LSDBA -a fixed limit of £1,073,100 (the current lifetime allowance) on the tax-free elements of lump sums that can be paid in life and death, to or in respect of an individual. This allowance will be used up by payment of a pension commencement lump sum, the tax-free element of an uncrystallised funds pension lump sum, as well as the tax-free elements of serious ill health lump sums and lump sum death benefits.
3. Overseas Transfer Allowances and charges – this allowance is equal to the level of an individual’s lump sum allowance (LSA) and lump sum and death benefit allowance (LSDBA) for transfers to Qualifying Recognised Occupational Pension Schemes (QROPS) – an HMRC recognised overseas pension scheme- and so provides equivalence for overseas transfers. Where the value of an individual’s transfers to a QROPS exceeds their available allowance, the excess will be chargeable to the overseas transfer charge.

One new lump sum - the Pension Commencement Excess Lump Sum (PCELS) – This allows members to commute additional pension as a lump sum, where the new lump sum allowance (LSA) or lump sum death benefit allowance (LSDBA) has been exhausted and is taxable, at the individual’s marginal rate of income tax. It will work in similar circumstances to those in which the current lifetime allowance excess lump sum could be paid but regulations, guidance and worked examples to clarify how this will operate in practice are still awaited. Overall, it has to be paid in connection with a pension and cannot exceed a permitted maximum. 

One new definition of “permitted maximum” for the Pension Commencement Lump Sum (PCLS) -The current treatment of a pension commencement lump sum (PCLS) has been retained so a pension commencement lump sum (PCLS) is still entirely tax free. It is limited to 25% of the value of benefits crystallising, subject to available lump sum allowances.

The permitted maximum for the pension commencement lump sum (PCLS) will be the lower of:

• The “applicable amount” (broadly 25% of the value of an individual’s benefits).
• Any available lump sum allowance.
• Any available lump sum and death benefit allowance.

The new concept of Relevant Benefit Crystallisation Events (RBCE) replaces Benefit Crystallisation Events (BCEs). These apply on:

• An individual becoming entitled to a relevant lump sum.
• An individual becoming entitled to a relevant lump sum death benefit.

They loosely replace the current tax position on BCEs 6 and 7 but are more limited. If more than one pension commencement lump sum (PCLS) or an uncrystallised funds pension lump sum (UFPLS) occur on the same day, the individual can decide the order of their RBCEs.

Scheme administrators must provide individuals with RBCE statements, telling them how much of their allowances have been used by the RBCE.

Where an individual received a BCE statement before 6 April 2024, they will now receive an annual RBCE statement.

What about lifetime allowances and lump sum protections?

Individuals with Enhanced / Fixed / Individual Protection keep their rights to the higher protected amounts. The deadline to apply for Fixed Protection 2016 or Individual Protection 2016 is 5 April 2025.

What should trustees do next?

Trustees should discuss these changes with their benefit consultants and pension administrators and: 

• pencil in regular updates at their meetings (and outside them) so they get to know and understand the new framework, as it develops. It is complex, for example some of the Finance Act 2024’s provisions were effectively backdated to March 2023 and some are forward looking to 2026. HMRC say they will be making Regulations on the changes up to 2026 but that they will not be passing any more Acts of Parliament on it. This means there is still limited certainty in practice on the changes to the tax regime, although we do have the main framework for it. 
• ask about the administration service and monitor what changes are being made to get this compliant.
• monitor what members and beneficiaries are being told about the changes on their behalf, and how this changes over time, as the law and practice develops. 
• start with a quick look through the trust deed and rules sooner rather than later from the legal perspective to make sure there are no immediate unintended consequences to deal with and consider whether adding a brief overriding rule could be beneficial.
• Add the subject to the risk register and overall risk assessment when this is conducted for the General Code. 

Trustees may also want to consider the overall level of benefits that most members have in their scheme, and if they are known to be relatively modest, then this light touch approach should be acceptable for the moment. This is particularly so given that some of the changes might have to be reversed or altered again if there is a change in Government and policy in this area. However, it seems unlikely that a change of Government could retrospectively impose a lifetime allowance charge for those who have already accessed their benefits if they have accrued that level of benefits at retirement.