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A whodunnit or an epic saga - the pension heist | AccountingWEB | picture of a person eating popcorn getting a fright while watching a screen

A whodunnit or an epic saga – the pension heist


The Treasury has long had pension tax breaks in its sights, but the latest plot turn, removing the pension Lifetime Allowance, has a potential sting in its tail. Andy Keates tries to decipher the Chancellor’s intentions.

4th Aug 2023
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When Chancellor Jeremy Hunt announced the abolition of the pension Lifetime Allowance (LTA), the realists among us knew that it was never going to be straightforward. A policy document issued on 18 July by HM Treasury illustrates just how complex it is likely to be.

Background to the pension changes

Since its introduction in 2006, the LTA has had the potential to influence all the occasions when money (either as lump sums or as income) leaves a pension scheme. By the time of its abolition, it stood at £1,073,100; amounts paid out in excess of that amount were exposed to the Lifetime Allowance Charge (LTAC), which for lump sums stood at 55%.

F (No 2) A 2023, s 18 removed the LTAC from 6 April 2023, while expressly recognising that the LTA itself was still intimately interwoven into the workings of pension tax law.

Section 19 showed that the LTA, or at least its spectre, would continue to be in effect for several lump sum payments. Among them is the “uncrystallised funds lump sum death benefit” – where an individual dies aged less than 75 without having previously accessed their pension pot, and it is passed on as a lump sum.

The value of these uncrystallised funds will no longer be measured against the LTA. Instead, they will be measured against a “new threshold” (which just happens to be equal to the value of the LTA immediately prior to its supposed abolition!).

Excesses over the new threshold will now be taxed as income at the recipient’s marginal rate rather than (as previously) 55%.

Loose ends from the abolition of the LTA

A number of the LTA’s legacy issues are “addressed” in the new policy document – albeit in ludicrously opaque phrasing which makes it hard to grasp exactly what is intended.

In good news, the new threshold will ignore any regular pension income being received by the member at the time of death. Previously, the available LTA was reduced by the notional capital value of the pension (basically, 20 x the income).

In further good news, any pension lump sums, including death benefits, taxed at the recipient’s marginal income tax rate will not count as income for the purposes of the Annual Allowance (normally £60,000, tapering down to £10,000 for high earners).

One area where the news may be less reassuring relates to drawdown funds.

A drawdown fund is created when a member of a pension scheme decides not to purchase an annuity, but instead assigns all or part of their pension pot into an arrangement from which they can withdraw an income whilst retaining the balance invested in the pension fund(s). Because no annuity has been purchased, the capital remains available to provide a death benefit to the member’s nominated beneficiaries.

Current drawdown death benefits

Since creating a drawdown arrangement is, under existing law, a “benefit crystallisation event (BCE)”, it has already consumed part of the member’s LTA and so, on death, the arrangement would not be subject to the LTAC.

Unless the deceased member was over 75 (or the beneficiary received the fund more than two years after death), there would be no tax on “inheriting” a drawdown fund. Furthermore, the beneficiary would pay no income tax on any subsequent withdrawals from the fund – in effect, they are withdrawals of capital.

Proposed drawdown death benefits

All lump sum death benefits will be measured against the “new threshold”, and any excess will be taxed as income at the recipient’s marginal rate – even if the deceased was under 75 at death. This new rule encompasses both crystallised and uncrystallised lump sums, which would presumably include existing drawdown funds.

If the member died with uncrystallised benefits, and these are used within two years of death to create a drawdown fund for a beneficiary (BCE 5C), or to purchase an annuity for a beneficiary (BCE 5D), the capital value of the funds so designated will be taxable (to the extent they exceed the £1,073,100 threshold) as income at the beneficiary’s marginal rate.

The policy document does not appear to say whether withdrawals from an inherited drawdown scheme will continue to be tax-free, although Steve Webb in the Financial Times appears to believe they will now be taxable.

What does it all mean?

The policy document is obscurely written, but the most likely interpretation is that inheriting a drawdown arrangement could potentially result in an income tax charge on the recipient. That will only apply where the deceased’s pension pot was greater than £1,073,100.

However, the Treasury has “insisted the consultation proposals… outlined only one possible approach”, so the jury is out on what the legislation will ultimately say. Added to this is the Labour Party’s stated intention to reimpose the LTA and LTAC if elected.

One potential outcome of the proposed new rules is, in the opinion of the Institute for Fiscal Studies, the removal of the “perverse incentive” to use a pension for the purpose of preserving inheritance rather than to fund retirement. Once again, that remains to be seen.

As a keen observer of the monstrous complexity of so-called “pensions simplification” since 2004, I for one am ensuring I have adequate supplies of popcorn: this show is by no means over.

Replies (1)

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By moneymanager
08th Aug 2023 02:38

And just think, all of this stems from "Pension Simplification".

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