Changes to pension taxation

The proposals mean that if you take pension benefits or die in this tax year your pension benefits are still tested against the lifetime allowance but benefits in excess of the limit have no charge.

Restrictions weren’t removed altogether but retain reference to the headline figure of the lifetime allowance: £1,073,100 to test Pension Commencement Lump Sums (PCLSs) with the maximum tax free lump available being 25% of this or £268,275.

If you had previously claimed pension protection which enabled you to have a higher lifetime allowance, this would mean you would be able to take a higher tax-free amount.

Legislation has now been published to abolish the Lifetime Allowance (LTA). The LTA has been replaced with two main new allowances; The Lump Sum Allowance (LSA), the Lump Sum and Death Benefits Allowance (LSDBA).

The standard allowance will be £268,275. If you have LTA protection you will have a LSA based on your protected LTA (e.g. if you have Fixed Protection 2016, you will have a LSA of £312,500 (25% of £1.25million).

The allowance will be reduced based on any previous lump sums that you take or have taken from pensions.

As an example, if you are taking benefits from a pension with a value of £400,000, having previously taken benefits from a pension worth £673,100:

You will have previously taken a tax free lump sum  of £673,100 x 25% = £168,275.

Your remaining lump sum allowance is £268,275 – £168,275 =£100,000

So, it will be possible to tax a tax-free lump sum from the pension of 25% or £100,000 within the new allowance. If your pension fund was larger, any excess would be taxed at your marginal rate of income tax.

The standard allowance will be £1,073,100. Those with LTA protections under the old rule will have a LSDBA based on their protected LTA (e.g. if you have Fixed Protection 2016, you will have a LSDBA of £1.25million).

The LSDBA will be reduced by any lump sum pension benefits that you take or have taken. This will include the lump sums previously taken into account for the LSA but is wider ranging – for instance serious ill health, or death benefits taken from other plans.

As an example, if you die with a remaining pension fund of £900,000, having taken previous PCLS of £250,000.

The total lump sum benefits are £900,000 + £250,000 =£1,150,000

This is in excess of the LSDBA so £1,073,100 can be taken tax free and the remainder will be taxed at your marginal rate.

These changes are in addition to the existing complexity around the options available for your pension fund on death. It is essential you review your existing plan to ensure the full range of options are available for your beneficiaries.

* Potentially taxable in beneficiaries’ estate

One of the challenges of the new rules is taking into account pension benefits you may have taken in the past.

This will be done by a standard calculation based on the ‘lifetime allowance previously used amount’.  This is the amount that would have been the previously used amount for the purposes of working out how much of someone’s lifetime allowance they had available under the old LTA rules assuming it was taken on 5^th April 2024.

The lump sum allowance is reduced by 25% of the previously used amount. That means if 100% of the lifetime allowance was used, the lump sum allowance is Nil.

Legislation is still in draft at present so may be amended but we now have a clearer picture of pension advice. There remain many questions – how easy will it be to get information on pension benefits taken many years ago and how prepared will pension schemes be to issue certificates before when they are required to keep records?

With the legislation issued just before Christmas we are analysing the detail to identify any action people may need to take in this tax year.