New Pension Puzzles (Removal of Lifetime Allowance)

Removing the cap on the pension Lifetime Allowance (LTA) may seem like a gift from the exchequer though it brings uncertainty for some pension savers and a few new puzzles to solve.

The Lifetime Allowance (LTA)

The LTA was broadly speaking the maximum pension you could hold before incurring extra tax charges. For most, this meant a total allowance of £1,073,100, split between tax free cash of up to £268,275 and a fund of £804,825 to provide taxable income.

If someone tried to withdraw more than their LTA, a 25% tax charge would apply to the excess plus the usual income tax on the remaining funds when withdrawn, or a flat 55% tax on lump sum payments. If the decision to withdraw the excess was deferred, HMRC would take their cut on the individual’s 75^th birthday or on death if after age 75. For most breaching the limit, the surplus tax was inescapable.

Therefore, on the face of it, removing the cap feels like great news…. that is, until you read the small print.

Tax Free Cash

A prized benefit of the pension regime is the entitlement to withdraw part of your savings tax free. Under the old regime most could withdraw 25% of their LTA without paying tax which is the same £268,275 available under the new “Lump Sum Allowance” (LSA). So what’s the fuss?

The government previously created legislation to allow the old LTA, and thus the tax-free cash allowance, to increase with inflation each year though in practice, it was frozen from 2020 to 2023 due to budget pressures and then was effectively abolished. There is no mention of similar increases to the LSA and some speculate that freezing the allowance indefinitely could be a new ‘stealth tax’ similar to the freezing of the personal allowance for income tax introduced in 2021 or the Inheritance Tax nil rate band, which has been static since 2009.

Stick or Twist?

Once someone has a pension worth £1,073,100 or more and has accumulated the maximum LSA (25% of their funds up to £268,275), the benefit of further pension saving could be marginal because continuing to grow their pension won’t increase the tax-free cash allowance. They will still receive income tax relief on contributions, but they will eventually pay income tax on the funds when withdrawn. There may still be a benefit to deferring income tax but to really understand if adding more to their pension is sensible, a whole host of factors need to be carefully considered including their current and future expected income levels.

Labour curve-ball

To add fuel to the fire, soon after the Chancellor announced plans to abolish the LTA the Labour party leadership said it would reverse the decision if elected! Labour has since acknowledged that this would be “far from straightforward” but considerable uncertainty remains. This makes it even trickier for someone who reached (or will reach) the old LTA to decide if further contributions are worthwhile or even if there is value to withdrawing benefits whilst the LTA is abolished i.e. before a newly elected Labour government potentially reintroduces the excess tax.

Protected LTAs

Due to the various pension regime changes over the years, many individuals have higher protected LTA’s and tax-free cash entitlements ‘grandfathered in’, normally on the condition that no further contributions are made. Another unanswered question is how any new Labour government would treat someone with a protected allowance making a contribution today? Under the current rules the individual would be able to keep their protected benefits but under the old rules (which may be reinstated) the protection would be lost. The difference could mean tens of thousands of pounds in tax. Labour are silent on how a reintroduced LTA regime would work in practice.

Takeaways

Clearly, the situation is very complex. The abolition of the LTA was seismic and many of the details are still being worked out, so the first takeaway is simply to watch this space. If you have a pension anywhere close to the old limits i.e. a fund of £1,073,100 or tax-free cash of £268,275 and you are interested to understand how these changes affect you, please feel free to Contact Us.

The value of investments and the income derived from them can fall as well as rise. You may not get back what you invest.

This communication is for general information only and is not intended to be individual advice. It represents our understanding of law and HM Revenue & Customs practice. You are recommended to seek competent professional advice before taking any action.

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