News & Insights

Navigating the End of the LTA: A Guide to the New Pension Tax Regime

As we move towards the imminent removal of the lifetime allowance (LTA) from pension taxation rules, expert analyst Ritchie Salkeld offers an in-depth look at the practical implementation of the forthcoming system. The countdown has begun for the LTA’s exit from the pension tax landscape, with its termination expected in just a few months. A comprehensive set of draft rules has been released, detailing the operational framework of the new system.

Last year’s Spring Budget, presented by the Chancellor, marked the beginning of this significant change, scheduling the LTA’s discontinuation for April 2024. Since that announcement, numerous legislative drafts have been circulated, amending existing laws and introducing new guidelines.

Under the incoming rules, pensions starting from the next fiscal year will be subjected to a threshold check primarily when disbursed as a lump sum. The new system introduces the lump sum allowance (LSA), designed to limit the amount of tax-free cash accessible from pensions during a person’s lifetime. Concurrently, the lump sum and death benefit allowance (LSDBA) will regulate the tax-free lump sum distributions after a member’s death. Notably, these limits won’t apply when funds are allocated for regular income generation, whether during the pension holder’s lifetime or after death, in cases where beneficiaries opt for ongoing income instead of a lump sum.

Interactions Between Old and New Rules

Before the release of the latest draft finance bill, there were uncertainties about how the existing rules would integrate with the new framework. This issue is especially relevant for clients with uncrystallised pension funds as of April 6, 2024, who have also availed pension benefits previously, thus consuming a portion of their LTA under the old system. A set of transitional provisions for pre-2024 benefits has been proposed to address this. These provisions are designed to adjust the available amount of LSA and LSDBA in the new system, based on the extent of LTA usage previously.

For instance, the LSA will be diminished by 25% of the LTA utilised. To illustrate, if a client has previously used 50% of their LTA, their LSA will be reduced by 12.5% (which is 25% of 50%) of £1,073,100, resulting in a reduction of £134,137.50. Therefore, the LSA would decrease from £268,275 to £134,137.50.

Regarding the LSDBA, the reduction criteria involve:

  • Subtracting 100% of the LTA for serious ill-health lump sums (SIHLS).
  • Deducting 100% for lump sum death benefits linked to a member who passed away before reaching the age of 75.
  • Reducing by 25% of the LTA utilised.

In most scenarios, barring prior SIHLS or death benefit lump sums, the reduction in LSDBA will be identical to that of the LSA. For example, using the same 50% LTA usage scenario, the LSDBA would also reduce by £134,137.50, leaving an available balance of £938,962.50.

If a client had fully utilised their LTA (100%) before April 6, 2024, both their LSA and LSDBA would be zero. This reduction will be computed the first time a client avails benefits on or after April 6, 2024.

The standard assumption in this calculation is that individuals would have withdrawn 25% of their funds as a pension commencement lump sum (PCLS) or tax-free cash at the time of initial pension access. However, this might only sometimes have been the case.

Alternative Calculations and Transitional Provisions

The new regulations introduce an alternative calculation method for individuals who withdrew less than 25% as tax-free cash at the start of their pension benefits. Suppose such individuals can provide evidence of the specific amount of tax-free cash taken, or confirm that none was taken. In that case, they can apply for a ‘transitional tax-free amount certificate.’ This certificate will indicate a different amount to be deducted from their allowances, diverging from the standard deduction of 25% of the LTA percentage used.

This alternative calculation could be particularly advantageous for clients who chose not to convert any portion of their defined benefit (DB) pension into a lump sum. For example, for a client who didn’t take a lump sum from their DB scheme and used 50% of their LTA, the standard transitional calculation would reduce their LSA by 12.5%. However, with the alternative calculation method, the LSA for such a client would remain the same.

It’s crucial to understand that while the certificate increases the allowance, the maximum PCLS amount is still capped at one-third of the fund allocated for income generation.

Pension schemes are currently grappling with the nuances of gathering and verifying historical data and the responsibilities providers will have in issuing these certificates. It remains to be seen under what conditions providers might refuse to issue these certificates, necessitating further guidance from HMRC. This guidance is expected to clarify the process of evidence collection and validation.

As we approach the abolition of the LTA in the new tax year, it’s essential to understand the complexities of the new system. The draft rules make it clear that, moving forward, only lump sum payments will be subjected to these new tests. The interaction between the old and new rules is a critical factor, particularly for individuals who have both crystallised and uncrystallised funds as of April 2024.

This communication is for informational purposes only and is not intended to constitute, and should not be construed as, investment advice, investment recommendations or investment research. You should seek advice from a professional adviser before embarking on any financial planning activity. Whilst every effort has been made to ensure the information contained in this communication is correct, we are not responsible for any errors or omissions.

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