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Two new allowances replace lifetime allowance

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The pensions lifetime allowance has been abolished but two new allowances will be introduced for retirement and death which will limit tax-free cash benefits.

27th Feb 2024
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In a speech at the Cambridge Union 45 years ago, Sir Rhodes Boyson MP announced the Rhodes Boyson Principle: “If it’s free, I’ll have two of them.” It’s something that has worried politicians of all stripes since the launch of the “free” NHS and the early run on free NHS spectacles. 

Although a lot of government money is thrown at pensions, it’s not quite free, as either the member or their employer does have to pay for contributions. However, the tax relief is extremely valuable and to protect the system from abuse we have to have limits. If you go back 20 years we had two sets of limits: one on the way in for defined contribution (DC) schemes, and one on the way out for defined benefit (DB) schemes. 

However, the 2006 reforms, dubbed “pensions simplification”, produced one combined tax system for both DC and DB, fixing limits both on the way in (the annual allowance), and on the way out (the lifetime allowance).

Off the rails

Seasoned travellers will know that if you look down from the platforms at both London Euston and Manchester Piccadilly, the rails are firmly bolted down at both ends. This leads to problems on the hottest of summer days as the steel rails expand and buckle in the middle, leading to delays and cancellations. The effect of having pension limits on both the way in and the way out causes similar problems, especially if there have been good investment returns in the middle.

For DC, these problems can lead to clients who cannot afford to retire. For DB, the problem is the opposite – clients often feel they cannot afford to carry on working. That resulted in a particularly noisy problem for the government when the affected group were senior doctors, whose services are very much needed by the nation.

It was the completely infructuous situation of a doctor volunteering for an extra shift to help clear a patient backlog but incurring a resulting pensions tax bill greater than the additional income earned that led to the Chancellor of the Exchequer announcing in last year’s Spring Budget that the lifetime allowance was to be abolished from 6 April 2024, and introducing some immediate transitional relief in the 2023/24 tax year.

New allowances

Perhaps mindful of the Rhodes Boyson Principle, and seeking to protect the public purse, HMRC has introduced two new allowances to replace the lifetime allowance. Both apply to tax-free cash, which is arguably the most generous of the various pension tax reliefs and, because of its immediacy, probably the most exploitable. The new lump sum allowance will limit the tax-free cash available at retirement while the lump sum and death benefit allowance will limit the tax-free cash available on death.

The situation at retirement is fairly straightforward and perhaps signals no change for most people. A self-invested personal pension (SIPP) or personal pension, held by an ordinary member with no protections brought forward from previous regimes, will allow a tax-free cash sum of 25% of the pension pot to be taken at retirement, up to a maximum of the new lump sum allowance of £268,275. 

It doesn’t have to be taken in one go, and all the familiar situations of vesting multiple pensions plans one at a time, partial vesting, drip-feed drawdown or uncrystallised funds pensions lump sum (UFPLS) can still be deployed, so that clients can commence their retirement income in the way that suits them best. Once they have taken a cumulative total of £268,275 of tax-free cash, all further cash withdrawn will be treated as taxable income.

Lump sum and death benefit allowance

Death is another matter. The member must keep records of all their tax-free cash at retirement, of any tax-free element of UFPLS payments and of any serious ill health pension payments received tax free throughout their lifetime. These are to be deducted from the new lump sum and death benefit allowance of £1,073,100, and the balance that is left will be tested against lump sum death benefits, excluding any charity lump sum death benefits or trivial commutation lump sum death benefits.

If death is before age 75, then a lump sum can be paid out tax free up to this remaining lump sum and death benefit allowance. Any lump sum in excess of this will be taxed as income in the hands of the individual receiving it, unless it arose from benefits that were crystallised before 6th April 2024. However, if death benefit is paid as income, such as with a beneficiary drawdown plan, then it can all be paid tax free.

If death is at age 75 or over, then the lump sum and death benefit allowance has expired, and the death benefit will be taxed as income in the hands of the recipient, irrespective of whether it is paid as a lump sum or as a beneficiary drawdown.

As we approach these changes on 6 April 2024, it seems that we now have clear legislation. However, readers need to keep a close watch on this area, as the government has retained the power to amend the legislation by regulation, which is easily done should the changes fail to meet their policy intent after implementation.

Replies (6)

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By jon_griffey
27th Feb 2024 12:40

It seems to me that introducing a new 'lump sum allowance' that starts to decouple the tax free cash from the value of the fund sets a bit of a precedent. It would seem relatively easy to reduce this 'allowance' from £268,275 to say £200K at the drop of a hat. They have form for this sort of things in reducing the annual and lifetime allowance. Should we all take our tax free cash now whilst we can?

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Replying to jon_griffey:
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By FactChecker
27th Feb 2024 16:08

With the obvious caveat that 'this doesn't constitute advice', quite probably (not)!

There are still a few bright young things (well not so young now a decade later) who lurk in the bowels of the Treasury - probably locked in darkened cupboards and fed on torn up pieces of the 'Wisdom of Dominic Cummings' - who were convinced they had the obvious solution:
* Reverse the overall tax balance so that Contributions become taxable whilst any pension payments are tax-free!
['Short-term gain in tax revenues; someone else's problem later' was explanation given to me.]

They may no longer have the influence they thought was their due, but whispering continues ...

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Replying to FactChecker:
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By DMS
28th Feb 2024 09:49

I think that is called an ISA?

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By johnfrancis
28th Feb 2024 09:55

"infructuous" apparently means pointless or unnecessary. What larks!

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By AndrewV12
28th Feb 2024 11:02

will allow a tax-free cash sum of 25% of the pension pot to be taken at retirement, up to a maximum of the new lump sum allowance of £268,275.

Death is another matter. The member must keep records of all their tax-free cash at retirement, of any tax-free element of UFPLS payments and of any serious ill health pension payments received tax free throughout their lifetime. These are to be deducted from the new lump sum and death benefit allowance of £1,073,100, and the balance that is left will be tested against lump sum death benefits, excluding any charity lump sum death benefits or trivial commutation lump sum death benefits.

Both are worth being aware of.

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Jeremy Gordon, DirectDocs
By Jeremy Gordon
29th Feb 2024 20:44

Thanks for your clear explanation of these changes Adrian.
I should mention that the effect of the old Lifetime Allowance and Lifetime Allowance Charge has been retained in the case of transfers of pension benefits to a QROPS. A new Overseas Transfer Allowance (OTA) (in the same amount as the old Lifetime Allowance) is introduced as from 6 April 2024 and a new Overseas Transfer Charge of 25% will be applied to transfers done after 6 April 2024 in so far as (in total) they exceed the OTA.
This was a last minute addition to the draft legislation and reflects the fact I suppose, that those who transfer their pension benefits to a QROPS are supposed to be emigrants to the country where the QROPS is established and therefore would not usually be still working back in the UK.

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