What the Lifetime Allowance removal means for your clients – here’s the current state of play

Much has changed since then-chancellor, Jeremy Hunt, stood in the House of Commons in March 2023 and announced that his government was abolishing the pension Lifetime Allowance (LTA).

We’ve had a 12-month transitional period so that the removal of the LTA could take place almost immediately (from all pension providers: a big “thanks” for that one, Jeremy!). In that time, we’ve also had:

A plethora of new acronyms to learn
A heap of new legislation from HMRC to try and make sense of
A suggestion that Labour would reinstate the LTA should they come into power
A denial that Labour would reinstate the LTA should they come into power
The abolition date (6 April 2024) come and go
Labour winning July’s general election.

IPM attended the annual conference of the Association of Member Directed Pension Schemes (AMPS) back in May.

Members of the AMPS committee have been liaising with HMRC over the new rules. The feedback from the committee was that there have been many unintended consequences of the LTA removal, with some changes in the legislation being incomplete or incorrect. Moreover, moving from percentages to monetary amounts has made amending existing legislation harder than anticipated.

Unfortunately, when pressed on when these issues were going to be resolved, or how to handle particular issues that arise in real-time, HMRC’s comment has been to suggest that clients delay their retirement decisions…

All this makes it extremely difficult to plan for clients’ futures and to answer the inevitable questions that head your way.

While we are unable to answer all these questions now, we thought it would be useful to summarise the current position.

The history of the LTA to its unexpected abolition

The LTA was first introduced on “A-Day” in April 2006.

It was designed to be an upper limit that individuals could accumulate across all pension pots and access tax-efficiently, usually including a pension commencement lump sum of up to 25% of the value of benefits.

Any amounts above the LTA (where LTA protection had not previously been obtained) were subject to a tax charge when a benefit crystallisation event (BCE) was triggered.

Originally, the LTA increased incrementally, from £1.5 million in 2006/7 to a high of £1.8 million in 2011/12. However, rather than following this trend, the LTA began to fall, down to £1 million in 2017/18 before going back up to £1,073,100 in 2023/24.

The reductions are where issues began to arise. Uncertainty about the LTA made retirement planning difficult and, as pension savings began to grow, the LTA affected more and more people. This was particularly the case for those with well-funded defined benefit arrangements.

Many commentators expected Jeremy Hunt to increase the LTA in the 2023 Spring Budget to combat this, but the chancellor surprised everyone by abolishing it altogether. While this sounded great at first, we have since learnt this has created its own problems.

Here’s the state of play in July 2024

Before 6 April 2024, the total value of benefits was tested against the LTA. Now there is no more LTA, it is the amount of tax-free benefits that will be tested.

To achieve this, several new allowances have been introduced:

The Lump Sum Allowance (LSA) of £268,275
The Lump Sum and Death Benefit Allowance (LSDBA) of £1,073,100
The Overseas Transfer Allowance (OTA) of £1,073,100

Checks are made against these allowances at the appropriate time, usually when benefits are being drawn under a relevant benefit crystallisation event (RBCE).

It is important to remember that these allowances may be higher if an individual has Lifetime Allowance protection, and that these are reduced if benefits were drawn before April 2024.

Although sounding similar to BCEs pre-April 2024, RBCEs are different in that they only apply to the tax-free element of lump sums (the LSA and LSDBA) and not income.

We also now have Transitional Tax-Free Amount Certificates (TTFAC), which some individuals can apply for. We’ll consider these further in a moment.

Lump Sum Allowance (LSA)

The LSA is a limit on certain lump sums paid during an individual’s lifetime. The standard LSA is £268,275 for those without transitional protection.

The payment of lump sums after 6 April 2024 are RBCEs and count towards the LSA. RBCEs in this instance include the:

Pension commencement lump sum (PCLS)
Tax-free element of an uncrystallised funds pension lump sum (UFPLS) payment.

Since 6 April 2024, when a client has taken a lump sum, the amount received is deducted from the remaining LSA. Transitional rules are in place where an individual has drawn benefits before this date and an adjustment to the LSA may be made to consider any tax-free cash that has been taken. Click here for a useful example.

It is important to note that lump sums that use up some of the LSA will also count towards the LSDBA, reducing the LSDBA available upon death.

Lump Sum Death Benefit Allowance (LSDBA)

In addition to the RBCEs listed above for LSAs, the LSDBA includes certain lump sums paid on death, and serious ill-health lump sums before the age of 75.

When looking at the LSDBA when a relevant lump sum is to be paid, any relevant lump sums paid since 6 April 2024 should first be deducted. There are transitional rules for benefits drawn before 6 April 2024 – click here to find examples of these.

Lump sums that are within the LSDBA will usually be paid tax-free. Any amount in excess of the LSDBA will usually be subject to Income Tax.

There are several instances where the LSDBA can be ignored. These include:

Lump sum death benefits from funds that were crystallised before 6 April 2024 (although the tax-free element originally received by the deceased will need to be taken into account)
Where a death benefit lump sum is being paid to a registered charity
Where the scheme member has died after the age of 75.

Transitional Tax-Free Amount Certificates (TTFAC)

One of the many challenges of the new regime is how to account for those individuals who had previously partially crystallised their benefits but may face a future test against the new allowances.

A standard calculation is carried out against the LTA previously used. The LSA is reduced by 25% of the previously used amount. So, if a previous BCE resulted in 100% of the LTA being used, the LSA available to take after 6 April 2024 is nil.

There is also an equivalent calculation for the LSDBA.

However, there are instances where the standard calculations can leave an individual in a worse position than intended. Transitional Tax-Free Amount Certificates (TTFAC) are provided by registered pension schemes to prove that an individual is entitled to a lower reduction of the LSA or LSDBA than the standard calculation (you can apply for one from IPM using this link).

Some of the examples where an individual may consider applying for a TTFAC include:

When a test against the LTA took place when the LTA was lower than £1,073,100 (that is, between 2016/17 and 2019/20)
Where an individual was in a defined benefit scheme but didn’t commute the pension for their full tax-free cash entitlement
When someone is over 75 and has “unused funds” – that is, they haven’t taken benefits yet. These benefits would have been tested against the LTA at age 75.

It is not a given that a TTFAC will result in an individual achieving a higher tax-free amount. For example, an individual may have taken a tax-free amount of less than 25% from one scheme but had an enhancement greater than 25% on another.

For those clients who took benefits before April 2006, it will not be possible to apply for a TTFAC as there were no BCEs before 6 April 2006.

Overseas Transfer Allowance (OTA)

From 6 April 2024, any transfer to a qualifying recognised overseas pension scheme (QROPS) is tested against the Overseas Transfer Allowance (OTA) of £1,073,100, less the amount equal to 100% of the value of their LTA used as of 6 April 2024.

Every time there is a transfer to a QROPS, the OTA is reduced by the value of the transfer.

If the transfer exceeds this amount, then the overseas transfer charge of 25% on the excess is deducted from the transfer.

Note that these new limits will only affect those with significant pension savings

In the above, we have attempted to simplify a complex area of pension legislation that is yet to be finalised. There is much more we could have covered!

That said, while advisers need to understand the framework of the legislation, these new limits will only affect those with significant pension savings, not all individuals.

The above is based on our understanding of the rules at the time of writing (July 2024) and is subject to change. We will produce further notes should there be any significant updates.

Get in touch

If you want to have a chat about these new allowances and how they may affect your clients, please contact us. Email info@ipm-pensions.co.uk or call 01438 747151.