Contributors
The Finance Bill issued on the 29 November 2023 introduced draft legislation to repeal the current Lifetime Allowance (LTA) regime and replace it with a new system of lump sum allowances. The changes are set to take effect from 6 April 2024: "L-Day".
The Finance Bill received Royal Assent on 22 February. However, HMRC intends to continue hosting LTA working groups, and to issue communications every two weeks, right up to L-Day.
All schemes are affected by what is a significant change, including those schemes that are closed to accrual or going through a buy-in/ buy-out process. There could well be unintended, irreversible consequences if no action is taken before L-Day.
The Finance Act contains wide powers to make further changes to legislation as required (even up to 5 April 2026) because it is so complex and has the potential to produce unforeseen consequences. However, we cannot be sure at this stage that these will "undo" any adverse consequences that have occurred in your scheme in the meantime.
What is happening to the LTA?
The LTA is the maximum amount an individual can accrue in their pension schemes during their lifetime without incurring a tax charge. Each time an individual experiences a "Benefit Crystallisation Event" (BCE) e.g. commencing a pension, receiving a lump sum, on death etc. a check will be performed against an individual's LTA to determine what portion of their LTA will be used up by that crystallisation event. If any amount exceeded the LTA the excess amount would be subject to a tax charge: 55% where the excess was taken as a lump sum; or 25% of the capital value where taken as pension income.
The standard rate LTA (currently £1,073,100), applies to most individuals, but some people who applied after 6 Aril 2006 for one of the forms of LTA protections will have a higher individual LTA.
Legislation passed after the Spring 2023 Budget only abolished the LTA charge for the 2023/2024 tax year only.
The Finance Bill 2024 will totally abolish the LTA; this is not insignificant. Some schemes may have benefits which are capped by reference to the current LTA (as a defined term), and that cap could fall away unless action is taken.
The two new allowances
Individuals will be subject to the following two new allowances:
- The "Lump Sum Allowance" (LSA). This is set at £268,275 (which is 25% of the current LTA). This allowance will be reduced by any Pension Commencement Lump Sum (PCLS) and the tax-free portion of any Uncrystallised Funds Pension Lump Sums (UFPLS). The LSA will not be reduced by trivial commutation and winding-up lump sums (although a member will be required to have sufficient LSA available to take such lump sums).
- The "Lump Sum and Death Benefit Allowance" (LSDBA). This is set at £1,073,100 (equal to the current LTA). This allowance will be reduced by PCLSs, the tax-free portion of UFPLSs, as well as any tax-free serious ill-health lump sums and the tax free portion of any authorised lump sum death benefits (with the exception of a charity death benefit lump sum or trivial commutation lump sum).
Any pension saving that falls outside any of these new allowances will be taxed at an individual's (or, where appropriate, a beneficiary's) marginal rate of income tax.
Benefit Crystallisation Event (BCE) changes
Once the LTA is abolished, the current BCEs will be redundant. In their place will be new BCEs relevant to the two new lump sum allowances, called 'relevant BCEs'. Whenever a 'relevant BCE' occurs, a check will be performed to determine how much of an individual's LSA or LSDBA has been used up by that event, and the LSA/LSDBA will be reduced accordingly.
Pension Commencement Excess Lump Sum (PCELS)
A new "Pension Commencement Excess Lump Sum" (PCELS) will be introduced, which is similar to the current Lifetime Allowance Excess Lump Sum (LTAELS) (which will disappear). It will only be payable when an individual's pension savings exceed their available LSA and LSDBA, in which case it will be taxed at the individual's marginal rate of income tax.
A PCELS can only be paid in connection with the commencement of a pension and cannot exceed a permitted maximum (which in some circumstances will be lower than the amount that would be permitted by way of LTAELS).
LTA protections
Following consultation, instead of the LTA protection regime falling away, the LSA and LSDBA will vary on an individual basis according to the level of LTA protection the individual already has. For example, an individual with valid fixed protection 2016 will have their allowances based on an LTA of £1.25m (as opposed to £1,073,100), so their LSA will be set at 25% of £1.25m (£312,500), and their LSDBA will be set at £1.25m.
Those with valid individual and enhanced protection will have similar treatment. Individuals who are eligible to apply for fixed protection 2016 and individual protection 2016 will have until 5 April 2025 to make such applications. No further applications will be taken after this date.
What should you be doing now?
Trustees and employers need to understand how the changes affect their Scheme and what (if anything) they need to do to prepare for L-Day to avoid unintended consequences. The key considerations for both employers and trustees will be:
- Do your rules need to be amended to remove or retain references to the old LTA regime, for pension and or death benefits? Should this be done before L-Day? It might be necessary to adopt an interim approach given how little time the Government has given schemes to prepare for this before L-Day.
- Are administrators ready to effect the proposed changes and to produce amended retirement statements? If not, what changes need to be made, and by when?
- Whether, what and how to communicate to members: booklets, newsletters, website content?
Employers should assess the arrangements they have in place for individuals under an unregistered scheme or Excepted Group Life scheme because their pension benefits or death benefit lump sums exceed the LTA. Despite the LTA abolition, these arrangements might still be beneficial to very high earners and employers should not be hasty in changing their strategy here, or employees (and their beneficiaries) could be adversely affected.
How can we help?
We can assist with the assessment of your scheme rules, and arrangements for high-earners, to identify whether changes in the rules, or in approach, are necessary. We are used to working in partnership with administrators to prepare communications on changes like this, and our legal review should feed into any L-Day project plan encompassing the communication process.
Get in touch with your regular Pensions team contact to get started with the process for your scheme.
This article was also authored by Kate Wortley, Solicitor at Womble Bond Dickinson.
