UK pensions: lifetime allowance changes

Describing the imminent tax changes as “complicated” would be an understatement.  For practitioners, a particularly challenging aspect of the new legislation will be that certain important terms (“relevant lump sum”; “relevant benefit crystallisation event”) have different meanings depending on which new tax allowance is being considered.  Some clarification is given in subsequent guidance, issued by HMRC on 20 December.

Here, we share our thoughts on some of the following key areas.

• Pensions: no longer subject to capital limit
• New lump sum allowances
• Pension commencement lump sum (PCLS)
• New pension commencement excess lump sum (PCELS)
• Transitional provisions: valuing previous BCEs

Pensions: subject to income tax only 

From L-Day, pension payments (whether taken as a scheme pension, income drawdown or from an annuity) from a registered pension scheme will be subject only to income tax, at the recipient’s marginal rate.  Gone will be the requirement to give a new pension a deemed capital value (tested against the old lifetime allowance (LTA)), or to apply any additional tax (such as the current LTA charge) if the capital value exceeds a certain amount.

This contrasts with the current LTA regime and the associated benefit crystallisation events (BCEs) which take account of both:

• The amount of relevant lump sums paid to or in respect of a member; and
• The capitalised value of any new pension entitlement.

Before April 2023 (when levying the LTA charge was suspended), if a member had used up all their LTA, any excess pension was subject to a 25% LTA charge in addition to marginal rate income tax.

Under the new tax regime, HMRC’s interests will be directed instead at recording and taxing lump sums in excess of new lump sum allowances.

New tax-free lump sum allowances

The world of UK pensions must get used to two new tax allowances:

• The “lump sum allowance” (LSA) of £268,275; and
• The “lump sum and death benefit allowance” (LSDBA) of £1,073,100.

Readers will notice that the LSDBA is equal to the level of the current standard lifetime allowance (LTA), with the LSA set at 25% of the LSDBA.

An individual’s LSA will be reduced by the amount of:

• Any previous pension commencement lump sum (PCLS); plus
• The tax-free part of any previous uncrystallised funds pension lump sum (UFPLS).

Broadly, lump sums above the individual’s LSA will be taxed at their marginal income tax rate.

A member’s LSDBA will be used up by any earlier:

• PCLS, UFPLS or serious ill health lump sum; plus
• The value of any authorised death benefit (other than a trivial commutation or charity death benefit lump sum) in respect of the member.

Pension commencement lump sum (PCLS) 

A tax-free PCLS may continue to be paid, subject to the same conditions as at present – that is, a PCLS may only be paid in connection with becoming entitled to a relevant pension (scheme pension, annuity or designating defined contribution (DC) funds for drawdown) and will be limited to 25% of the total value crystallised. 

The member also needs sufficient lump sum allowance (LSA) and lump sum death benefit allowance (LSDBA) to cover the amount of the PCLS.  As the LSA is used up by the amount of any previous PCLS and the tax-free parts of any previous uncrystallised funds pension lump sum (UFPLS), this caps an individual’s total PCLSs (plus tax-free UFPLSs) at £268,275.

Pension commencement excess lump sum (PCELS) 

A new type of authorised lump sum will be created, to be known as a PCELS.  At the same time, the current lifetime allowance excess lump sum (LTAELS) will be abolished, with references in scheme rules to an LTAELS to be read, wherever possible, as referring to a PCELS.

So is a PCELS just a renamed LTAELS?  Not really…

A PCELS is similar to the old LTAELS in that a PCELS may only be paid when, effectively, a member has used up all their lump sum and death benefit allowance (LSDBA).  Given that the LSDBA will be set at £1,073,100 – the same as the current standard lifetime allowance (LTA) – a member may only take a PCELS when they have already taken benefits up to the value of the LTA.  So far, so similar…

However, a PCELS may only be paid in connection with the member becoming entitled to a relevant pension and must not exceed (broadly) four times the amount of that pension. In contrast, before April 2024 a LTAES could be paid entirely in lump sum form, where the member had exceeded their LTA and without the need for any connected pension to come into payment at the same time.  

It is not clear whether the requirement for a connected pension is really the policy intention.  It’s worth bearing in mind that the PCELS legislation is new (and so was not subject to scrutiny by the pension industry this summer).  The PCELS provisions close the loophole, identified by the industry in the July draft legislation, which would have allowed near-full DB commutation – but they create another anomaly.

Transitional provisions: valuing previous BCEs

Pension reform never starts with a clean slate.  Here, the issue is how to take account of pension and lump sum benefits already put in payment before L-Day (on the occurrence of previous benefit crystallisation events (BCEs)).  This presents two particular challenges:

• Old-style BCE statements given to members when a BCE was triggered usually show the percentage of the lifetime allowance (LTA) used up – but from 6 April 2024 it will be the amount (not percentage) of a lump sum which is important; and
• Pre L-Day statements of a member’s LTA usage take account of both lump sum and pension values – but under the new lump sum allowances it is only lump sums (or the tax-free part of lump sums) which are considered. 

Transitional provisions set out what must be done to account for pre L-Day BCEs.  Somewhat confusingly, these will be housed in a schedule to the Finance Act 2024 itself rather than as additional provisions in existing legislation. 

There will be two alternative ways to determine how much lump sum allowance (LSA) an individual has used up by pre L-Day BCEs:

• The default method: deduct 25% of the aggregate of the values crystallised by the pre L-Day BCEs (adjusted to reflect earlier changes in the level of the LTA).  This method assumes that the member took 25% of the crystallised value as a tax-free lump sum (most commonly a PCLS or the tax-free part of an uncrystallised funds pension lump sum (UFPLS)).
• The real-data method: if the member has a “transitional tax-free amount certificate” in force showing the total tax-free lump sums actually taken under the pre-2024 regime, then this figure may be used rather than one derived from the default calculation.  This method may be particularly helpful where a member previously became entitled to a defined benefit (DB) scheme pension and decided not to commute the DB pension for a tax-free lump sum.

An individual may apply for a transitional tax-free amount certificate from any registered pension scheme of which they are a member.  To do this, the member must supply “complete evidence” of previous lump sums taken.  The scheme administrator will then have three months to issue either the certificate or notify the individual that the application is refused.  The practicalities of providing such a certificate will arise in due course – especially if the scheme giving the certificate is not the same as the one that paid the lump sum. 

Authored by the Pension Team.