Lifetime allowance guidance from HMRC

Ahead of April 2024 when the lifetime allowance (LTA) will be abolished, HRMC has published a second Lifetime allowance guidance newsletter. The first newsletter was published in March 2023 after the Spring Budget of that year when the scrapping of the LTA was originally announced.

Some of the areas of interest in the newsletter are:

Pension commencement lump sums (PCLS)

HMRC confirmed the legislation aims to maintain the current treatment for PCLS. This means that it is limited to the lower of 25% of the member’s benefits crystallising, or so much of the member’s lump sum allowance (LSA) or lump sum and death benefit allowance (LSDBA) available when the member becomes entitled to the lump sum. The PCLS will remain free of tax.

Pension commencement excess lump sums (PCELS)

There is a new authorised lump sum payment – a PCELS. A PCELS allows members to take a lump sum in excess of their LSA when they take their pension, and the scheme rules permit the payment. This is primarily aimed at public sector schemes that have an automatic right to a lump sum of three times their pension.

A PCELS is only available where the individual has used up all of their LSA and the total of capital value of the member’s scheme pension exceeds their LSDBA. A PCELS will be subject to income tax at the member’s marginal rates.

Dependants’ or nominees’ flexi-access drawdown pension or annuity (BCE 5C and BCE 5D)

HMRC confirmed that death benefits payable as flexi-access drawdown or annuity remain free of tax where the member dies under the age of 75, regardless of the value, i.e. no LSDBA applies to payments made in this way.

Enhancement factors

The Finance Bill 2023/24 confirms that LSA and LSDBA enhancements will be available where an individual:

• holds primary protection (primary protection factor);
• has acquired rights before 6 April 2006 under a registered pension scheme by virtue of becoming entitled to a pension credit (pre-commencement pension credit factor);
• has acquired rights under a registered pension scheme by virtue of becoming entitled to a pension credit (pension credit factor);
• has been a relevant overseas individual whilst an active member of an arrangement under a registered pension scheme (non-residence factor);
• has transferred rights from a recognised overseas scheme to a registered pension scheme (recognised overseas scheme transfer factor).

The LSDBA will be increased for all the above but only those with primary protection and pre-commencement pension credits will have an enhancement to their LSA. This is in line with the current position. The level of increase to an individual’s LSA and LSDBA will be capped at the entitlement they had built under the LTA.

LTA protections and enhancements — application deadlines

The application deadline for both fixed protection 2016 and individual protection 2016 is 5 April 2025.

International enhancements and pension credit enhancements

The deadline to apply for either of these enhancements where eligible is 5 April 2025.

Lump sum death benefits

Where a member dies under the age of 75 and some or all of the lump sum death benefits are taxable, i.e. the benefit exceeds the LSDBA, the payments will continue to be paid out by the scheme without a tax deduction.

The responsibility for identifying a chargeable amount and reporting this to HMRC will rest with the personal representatives. The process currently applies to defined benefit lump sums and uncrystallised funds lump sum death benefits. It will also be extended to the following payments:

• pension protection;
• annuity protection;
• drawdown pension fund;
• flexi-access drawdown.

The new rules bring drawdown payments into scope in terms of testing against the LSDBA, whereas previously they would not have been tested against the LTA.

However, HMRC also confirmed that any drawdown payments that were crystallised before 6 April 2024 will not be included in the limit on tax-free lump sum death benefit payments.

Transitional arrangements

The transitional arrangement rules explain how to account for benefits taken before 6 April 2024 under the new regime.

Individual’s LSA

An individual’s LSA is calculated by deducting 25% of the amount of the individual’s LTA previously used as of 6 April 2024.

Where the individual has used up all of their LTA, their LSA will be set to zero.

Individual’s LSDBA

An indvidual’s LSDBA will also be reduced by 25% of the amount of the LTA previously used, except where they have received a serious ill health lump sum before 6 April 2024. In the case of serious ill health lump sums, the amount is reduced by 100% of the LTA previously used.

As with the LSA, where the individual has used up all of their LSDBA their LSA will be set to zero.

Transitional tax-free amount certificates

Those with complete and accurate records of the tax-free cash amounts they have previously received may ask the scheme to use this evidence instead of the calculations set out above.

This is aimed at those who have previously taken benefits but not taken their full tax-free cash entitlement – primarily this will be those in defined benefit schemes.

Any updated tax-free amounts will replace the 25% or 100% figures in the above calculations.

For more information about the lifetime allowance, read our article, ‘Understanding Pension Lifetime Allowance’ here.

If you would like to discuss the upcoming changes, please contact your usual TPO adviser.

This information is correct as at 16/01/24.

The information in this article is based on current laws and regulations which are subject to change as at future legislations.

This article is intended for general information only, it does not constitute individual advice and should not be used to inform financial decisions.

The Financial Conduct Authority (FCA) does not regulate tax advice or estate planning.