UPDATED The abolition of the lifetime allowance from 6 April 2024 - key changes

Only lump sums are tested

Two new allowances are being introduced - the Lump sum allowance and the Lump sum and death benefit allowance.

The lump sum allowance

This limits the tax-free lump sums payable to the member in their lifetime.  The limit is set at £268,275 but can be higher for those with LTA protections.

The lump sum allowance (LSA) of £268,275 is a maximum. Tax-free cash entitlement is also still limited in the same way as it always has been, i.e. to 25% of the value of the uncrystallised funds or one third of the amount designated to provide income.

Any lump sum paid in excess of the LSA will be subject to income tax at the member’s marginal rates. 

Anything paid as pension income will not be tested and will be subject to income tax in the normal way.

The lump sum and death benefits allowance

This limits the amount of tax-free lump sum that can be paid both in lifetime and on death. The lump sum and death benefit allowance (LSDBA) is set at £1,073,100 but can be higher for those with LTA protections.

Where the client has taken any LSA during their lifetime, this will reduce the available LSDBA paid on death.

If death occurs before age 75, anything paid as a lump sum above the available LSDBA will be taxed at the beneficiary’s marginal rates of income tax. 

Lump sums paid on death from drawdown funds will be tested

Any funds moved into drawdown from 6 April 2024 will be tested against the LSDBA if they are later paid as a lump sum on death.  This differs from the position under the LTA rules where benefits on drawdown were not included in any tests on death. The reason for this is that the funds will not be tested when they are designated to drawdown as they are being used to provide income rather than a lump sum. They will therefore be tested against the LSDBA if paid out as a lump sum on death.  

However, any funds placed into drawdown before 6 April 2024 will not be tested against the LSDBA on death. The logic being that they will have already been previously tested under the LTA and so should not be tested again.

  Where clients have benefits in excess of the LSDBA, they should ensure that the option of paying death benefits as beneficiary’s drawdown is available wherever possible. This will mean that, in the event of death under the age of 75, all benefits could continue to be paid free of tax regardless of the value.   

There will be no Age 75 tests

The age 75 tests on funds in drawdown and any uncrystallised funds will no longer apply. This is because no lump sums are paid out of the scheme and so there is nothing to test.

Any tax-free cash taken age 75 or over will be subject to the LSA in the normal way along with the tax-free element of any UFPLS payments.

 Accounting for benefits taken before 6 April 2024

From 6 April 2024, only lump sum payments are tested against the limits and for those taking benefits for the first time the rules are relatively straightforward. However, many clients will have already taken benefits prior to 6 April 2024 and these need to be taken into account.

 To achieve this, the client’s previously used LTA percentage will be converted into a reduction in both the LSA and the LSDBA.

Where the client has previously used 100% or more of their LTA, under the standard calculation method there will be no entitlement to either LSA or LSDBA. Where the LTA used is less than 100%, both the LSA and LSDBA will be reduced by 25% of the total LTA previously used.

Example

A client has previously used 60% of the LTA. In monetary terms this is £643,860. Both their LSA and LSDBA will be reduced 25% of this value, i.e. £160,965.

Therefore, their LSA will reduce to £107,310 and their LSDBA will reduce to £912,135.

As well as the standard method of valuation, clients can also apply for a transitional tax-free cash certificate where they previously received less tax free cash than assumed under the standard calculation method.

This option will primarily be of benefit for those who have taken their defined benefit pensions without the maximum tax-free cash entitlement, because of either restrictions in the scheme rules or unattractive commutation factors.  It can also benefit others such as those who took benefits when the LTA was less than £1,073,100.

Example 

A client took their defined benefit pension of £30,000 a year in June 2017, when the LTA was £1m. They took no tax-free cash. This will have used up 60% of the LTA, i.e. £30,000 x 20/£1m.

Under the current rules, they would now be restricted to tax-free cash of 25% of 40% of the LTA. The change will allow them to take up to the full £268,275, providing they still have uncrystallised funds worth £1,073,100 or more.

Protected LTAs provide higher LSA and LSDBA

 Those with protected LTAs will maintain their higher tax-free cash entitlement as they will have a higher LSA. The higher protected LTA will also translate into a higher LSDBA.  

Example

A client with Fixed Protection 2014 will have a LSA of £375,000 and an LSDBA of £1.5 million.

Where those with LTA protection have already crystallised some of their benefits prior to 6 April 2024, their LSA and LSDBA will be reduced in the same way as those with the standard allowances as described above.

Example

A client with Fixed Protection 2016 used up 40% of their LTA. Their LSA and LSDBA are both reduced by 25% of this. Their LSA is reduced by £125,000 to £187,500. Their LSDBA is reduced from £1.25m to £1,125,000.