HMRC has issued it draft policy paper on the abolition of the lifetime allowance (LTA) and rules for 2024/25 onwards. The draft sets out the tax treatment of pension benefits once the LTA is removed (April 2024) and when lump sums can be paid tax free.
Many will be aware that the Spring Budget March 2023 confirmed that the tax charge for exceeding the LTA (the maximum you can build up in pension value during your lifetime) was reduced to 0% meaning people are not discouraged from working and building up larger pension funds. The Budget confirmed:
- Exceeding LTA tax charge = 0% from April 2023
- LTA to be abolished from April 2024.
Impact on Tax Free Cash Lump Sums (the 25% bit)
These are now capped at 25% of the LTA for 2022/23 (£1,073,100) = £268,275.
New Pension Terminology To Learn:
Lump Sum Allowance (LSA)
- The LSA is set at £268,275 (see above for origins).
- LSA is the maximum tax-free lump sum that can be taken collectively from all pension funds combined.
- You must include any tax-free lump sums for uncrystallised funds pension lump sum (UFPLS), triviality pensions (small pots) and pension lump sums on scheme wind-up.
Lump Sum and Death Benefit Allowance (LS&DBA)
- The maximum that can be paid out tax-free on death to beneficiaries is the old LTA of £1,073,100 and must include the following:
- Defined benefit scheme lump sum death benefits.
- Pension fund and annuity death benefits.
- UFPLS fund death benefits.
- Capped Drawdown and Flexible Drawdown death benefits.
- Triviality pension death benefits.
- Serious ill-health lump sum benefits.
- Any tax-free cash lump sums already paid out from any of the above.
Taxation if Exceed LSA and LS&DBS
- The old rule that benefits paid out on death before age 75 are tax free is removed. Whether you die before or after age 75, the following taxation rate apply to all beneficiaries.
- Beneficiaries must pay income tax at their normal rate of income taxes on any excess over the LSA or LS&DBA.
- If the beneficiary is a trust, for excess payments over the LSA or LS&BDA, 20% income tax is payable unless the trust receives the benefit 2 years after death, then 45% income tax is payable.
The LTA was not increased in line with inflation from tax year 2022/23 for the current tax year 2023/24. The old LTA is therefore frozen meaning the maximum tax-free cash amount is also frozen. Is this a backdoor for HMRC gradually taxing more and more of your pension fund over the coming years?
- The above rules simplify benefit crystallisation events (BCE) i.e., checks against allowances are only applied on the LSA.
- There has been no mention of the LSA or the LS&DBA increasing with inflation. If they are frozen, then by stealth, more of our high value pensions will be taxed.
- The natural progression of the above statement is that in the years to come eventually virtually all our pension lump sums and death benefits will be taxable.
- Is this a forerunner to no more tax-free cash on pensions i.e., all pension benefits being taxable?
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