During the budget announcement yesterday, Jeremy Hunt revealed that the Annual Allowance, Money Purchase Annual Allowance, and income level for the tapered Annual Allowance would all be increased, allowing people to save more into pensions without incurring tax charges. In addition, it was confirmed that the Lifetime Allowance will be abolished ensuring that no-one will face a Lifetime Allowance charge which previously could be as high as 55%.
However, will abolishing Lifetime Allowance benefit your clients more than increasing the current Lifetime Allowance, and how will this work in practice?
Lifetime Allowance (LTA) was introduced in 2006, and the value has changed over the years from a maximum of £1.8 million to the lowest of £1 million in 2016, of which individuals could take up to 25% tax free.
Each time benefits are accessed from pensions a Benefit Crystallisation Event (BCE) occurs and tested against the LTA. These BCEs were tracked over your lifetime until either age 75 or death where a final BCE happened. If an individual BCEs exceeded the Lifetime Allowance, charges would become payable which could be 55% if treated as an excess lump sum or 25% as excess income (which would be further subject to income tax).
Further complexities were introduced to build in HMRC Protections each time the Lifetime Allowance was reduced, these include Primary Protection, Enhanced Protection, Fixed Protection 2012, 2014 and 2016 and Individual Protection 2014 and 2016. Each Protection type had their own rules and requirements, which made retirement planning a minefield.
While the prospect of no longer incurring hefty charges when withdrawing pension benefits and eliminating the complexities of Benefit Crystallisation Events and Protection basis may seem appealing for both you and your clients, the question remains whether the implementation of this change will indeed be straightforward.
Reviewing the detailed proposal published by the government, there are still questions to be answered. The proposal has confirmed that the amount an individual can receive tax free will still be limited to 25% of the current Lifetime Allowance, unless protection applies. As the current Lifetime Allowance is £1,073,100 the maximum an individual can receive across all their pension schemes will be limited to £268,275 or their protected tax free limit.
This raises some questions on how this will be treated in the future. Will this value be fixed indefinitely? How will administrators track the amount of tax-free cash taken? Therefore, those protections will still need to be handled in calculations.
As well as the tax free cash calculations, the government’s proposal has confirmed a change in the taxation on payment of serious ill-health lump sum (SIHLS), defined benefits lump sum death benefit (DBLSDB), and uncrystallised funds lump sum death benefit (UFLSDB). At present, these are assessed against the client’s Lifetime Allowance (LTA) upon their death, and any amount that surpasses their LTA is subjected to a 55% LTA charge. However, this is set to be replaced with taxation at the individual’s marginal rate.
Does this mean that the whole lump sum is now subject to income tax, or is it only the excess over a ‘notional Lifetime Allowance’ that it is tested against?
For those trying to modify processes to take into account these changes, there are still many questions outstanding.
Therefore, will abolishing Lifetime Allowance actually benefit your client more than increasing the current Lifetime Allowance? Obviously abolishing Lifetime Allowance doesn’t adversely affect your client compared to indefinitely freezing the current threshold, however if the Lifetime Allowance was instead increased to the rumoured £1.8million, or even by CPI each year, it may have been more beneficial for some. The cap on tax free cash has remained, therefore a greater value of pension will be subject to income tax.
While it’s true that there will be no more LTA charges from April 2023, it is important to note that there may be a significant increase in the amount of income tax payable by your clients.