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Draft Finance Bill 2024: Removal of LTA and relief at source measures

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In this insight we provide an outline of the Finance Bill 2024 measures that will remove the lifetime allowance (the LTA) on and after 6 April 2024. The removal of the LTA is complex, and schemes will need to understand how the tax regime will work following its abolition. Our article should provide a useful guide to the key elements of the proposals.

LTA removal consultation

The Chancellor’s Spring Budget 2023 announced that the LTA would be abolished entirely on and after 6 April 2024. The Finance (No. 2) Act 2023 started by removing the LTA charge as from 6 April 2023, replacing it with a charge to income tax at the individual’s marginal rate.

On 18 July 2023, HMRC and HM Treasury published a joint consultation on draft Finance Bill 2024 measures that will implement the LTA removal. Also published are explanatory notes and a policy paper providing relevant background. The consultation closes on 12 September 2023.

The draft legislation contains two potentially significant changes that were not referenced in the Budget: (1) there being no limit on the amount of authorised lump sums that can be taken, just a limit on the amount that can be taken without income tax, thus potentially opening up defined contribution (DC) pension freedoms to the defined benefit world – albeit HMRC is looking at whether this possible expansion should be curtailed; and (2) possibly applying tax to DC benefits on a member’s death under age 75.

What is the LTA?

The LTA is the total amount a person can save in a registered pension scheme without there being additional tax charges. When introduced in April 2006 it was set at £1.5m, reached £1.8m in 2010/11, was reduced on three separate occasions to an eventual £1m and, following indexation, currently stands at £1.073m.

Present position

The LTA is used in a wide range of ways for the purposes of the current pensions tax regime, all of which need to be considered as part of its removal. This makes the LTA abolition complicated.

  • Lump sums: Individuals must have available LTA for certain lump sums such as the pension commencement lump sum (a tax-free lump sum, the PCLS) and an uncrystallised funds pension lump sum (an UFPLS) to be paid. The maximum amount of PCLS and UFPLS that can be taken is based on an individual’s available LTA – for both lump sums the maximum for somebody with a standard LTA is £268,275.
  • Lump sum death benefits (LSDBs): Certain LSDBs over the individual’s LTA are subject to tax. This was the LTA charge until 6 April 2023 when it was replaced with a charge to income tax at marginal rate.
  • LTA protections: Protections have been made available when the LTA was first brought in and, subsequently, when it has been reduced for those who anticipated having pension savings above the relevant LTA. These protections also give individuals a right to a higher level of PCLS and higher tax-free amounts of lump sums tested against the LTA.
  • BCEs: When a benefit crystallisation event (a BCE) arises, a check must be carried out as to the amount that is ‘crystallised’ by the event and whether the benefit exceeds a member’s available LTA. A BCE arises, for example, when a defined benefit (DB) pension is payable, DC funds are designated to drawdown, and when a member becomes entitled to certain lump sums. If the amount crystallised exceeds the individual’s available LTA, a charge to income tax can arise (which, between 6 April 2006 and 6 April 2023, was the LTA charge – 55% for excess LTA lump sums and a 25% charge on top of income tax for excess LTA pension).

Proposals – removal of LTA and introduction of two new lump sum allowances

The LTA removal will involve the following key proposed changes.

Proposal 1: Removal of LTA

There will no longer be a LTA which limits pension savings on and from 6 April 2024 – pension benefits will just be subject to income tax. It also means that it will no longer be necessary to have available LTA to take lump sum payments.

Instead, a new tax regime for lump sums and LSDBs will apply with the introduction of two new allowances: a new ‘lump sum and death benefit allowance’ of £1.073m, and a new ‘lump sum allowance’ of £268,275.

These two allowances signify new maximum lump sum amounts above which marginal rate income tax will be applied. The proposal is that that there will be “no limit on the size of authorised lump sums and lump sum death benefits, only a limit on the amounts not subject to income tax”. Regular pension income is not going to be included within the allowance tests.

Proposal 2: Lump sums and LSDBs – two new allowances

New ‘lump sum and death benefit allowance’ of £1.073m: Following removal of the LTA, certain authorised lump sums and LSDBs will not attract a tax charge where the lump sum does not exceed £1.073m (the current standard LTA). Payments above this level will be subject to income tax at the recipient’s marginal rate. The new limit is a personal limit – it is a test of the total value of lump sums paid and will apply across all registered pension schemes for all lump sums and LSDBs.

New ‘lump sum allowance’ of £268,275: The maximum tax-free limit for a PCLS (and UFPLS) will remain frozen at £268,275, other than for individuals with existing protections in place that entitle them to take a higher lump sum. Other lump sums such as trivial commutation and winding up lump sums will also be assessed against this allowance. Payments above this level will be subject to income tax at the recipient’s marginal rate. This new allowance will sit under the overall £1.073m.

This could represent a significant change for DB schemes because the draft legislation as it currently stands seems to allow a higher PCLS to be paid than is presently the case. Of course, any right to a higher PCLS would depend on a scheme’s rules allowing this – an entitlement to a higher PCLS is not an automatic right. Furthermore, HMRC’s Newsletter 152, which discusses the proposed changes, recognises the potential impact of this and asks for views on whether restrictions should be introduced for the PCLS going forward to prevent ‘unforeseen circumstances’ as it is not the Government’s intention to “significantly expand pension freedoms”.

LSDBs where a member dies under age 75: the LSDB will count towards the deceased member’s lump sum tax free limit with the excess to be taxed.

Proposal 3: Death of a DC member before age 75 with uncrystallised funds

At present, if a member with DC benefits dies under age 75 and has uncrystallised funds, these can be provided to a beneficiary through drawdown or an annuity without a charge to income tax. Although the draft legislation does not alter this, the policy paper notes that paying unused death benefits as an UFPLS or an annuity will incur income tax indicating a change in policy. HMRC welcomes feedback on this area.

Proposal 4: Protections and lump sum protections

The policy paper notes the intention is that those with valid lump sum and LTA protections keep their rights to higher levels of tax-free lump sums and, where applicable, higher tax-free parts of lump sums.

Individuals will have until 5 April 2025 to apply for fixed protection 2016 and individual protection 2016 – these protections were made available when the LTA was reduced in April 2016.

Certain restrictions for individuals with valid enhanced protection and a protected pension age below 50 will be introduced.

Members with enhanced protection, fixed protections 2014 and 2016 were subject to benefit accrual restrictions – the Finance (No. 2) Act 2023 removed these restrictions where a valid application was made for the protection before 15 March 2023.

Proposal 5: Removal of certain BCEs and charges

The removal of the LTA means that most BCEs will no longer need to be checked against the available LTA and can also be removed as a BCE. The BCEs being removed include those relating to taking a pension and where there are unused pension funds at age 75 or upon death. BCEs relating to the payment of relevant lump sums and LSDBs will remain because they need to be tested against the new lump sum allowances with payments above the limits triggering a charge to income tax – these will be classed as ‘relevant BCEs’ in the legislation.

Repeal of LTA charge interim provisions in the Finance (No. 2) Act 2023

The interim Finance (No. 2) Act 2023 provisions, which disapplied the LTA charge on and from 6 April 2023 replacing it with a charge to income tax, will be repealed because the Finance Bill will introduce a new permanent regime that will sit within income tax legislation.

Transitional provisions

There is no detail yet of how members who have taken benefits during the existence of the LTA will be treated.

Next steps

There are various matters that schemes will need to address as part of the pensions tax changes.

  • Schemes will need to assess whether the 6 April 2023 pensions tax allowance changes and the removal of the LTA will impact the scheme and whether there are any references in the scheme rules that need further consideration.
  • They will also need to think about member communications and whether and how general communications such as those relating to retirement need to be updated (being cautious as to the requirement not to provide financial advice).
  • Administration processes will have to be adjusted.
  • Pension and life assurance arrangements that have been set up to deal with LTA matters will also need to be considered.

There is a lot that both schemes and the Government in terms of legislation will need to put in place before the changes are introduced. Schemes should ensure that they are ready for the regime overhaul due to take place next April and begin liaising with advisers if they have not done so already.

Amendments to relief at source

The Finance Bill 2024 will also modernise the way registered pension schemes that use relief at source claim tax relief on members’ pension contributions from 6 April 2025 by moving from a paper system to a digitised one.

Relief at source involves pension contributions being made after tax has been deducted with the scheme reclaiming the basic rate of tax for the member from HMRC and adding this to the member’s pension contributions.

The policy paper explains that the relevant legislation, including the Finance Act 2004, needs to be amended to take account of digitisation. Regulations will stipulate how schemes will claim tax relief. Non-compliance will be a ground for de-registering a scheme. The legislation will also set out different relevant rates (for Scotland, Wales and the basic rate) as necessary.

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