Navigating the New Landscape of Pension Allowances

In comparison to the March 2023 Budget, the most recent edition was quite uneventful (a bit less National Insurance for working people and a bit more tax for everybody due to the freezing of tax bands). 

 

New Pension Lump Sum Allowances 

Casting our minds back to just over a year ago, in the run-up to Budget Day there was heavy speculation, in the pensions industry at least, that the Chancellor would reset the Lifetime Allowance for the value of pension benefits to £1.8m, from its previous figure of £1,073,100.  It was also suggested that the Annual Allowance for contributions might be reduced. 

 

Rabbits out of hats 

As it turned out, Jeremy Hunt surprised everybody by announcing that the Lifetime Allowance would be scrapped altogether from 6th April 2024, but that the maximum amount of tax-free lump sum anyone can take from pensions would be capped at the odd-looking figure of £268,275 (25% of the old Lifetime Allowance).  The Annual Allowance was raised to £60,000. 

These seemingly simple rules have, for some, created a great deal of complexity.  Pension technical experts and financial advisers have spent countless hours poring over the legislation to understand the consequences for individuals.  In short, two new allowances have been created – the Lump Sum Allowance (LSA), and the Lump Sum and Death Benefits Allowance (LSDBA). 

 

Rabbit warrens 

If you haven’t yet taken any pension benefits, it’s fairly straightforward.  You can take a tax-free lump sum up to 25% of the pension fund value, with a lifetime total tax-free limit of £268,275 – the Lump Sum Allowance.  So, if your pension fund is worth £300,000, you can take up to £75,000 tax-free.  If your pensions are worth £2m (after a lifetime of diligent saving!), the maximum tax-free amount is £268,275.  You might be entitled to more if you have one of the old forms of ‘Transitional Protection’. 

The less obvious change is that once you have taken your lump sum, there is no limit on the remaining value from which you take income (although any income drawn is taxable).  There is no capital tax on exceeding the old Lifetime Allowance. 

But if your pensions are fairly generous, and you have taken part of your pension benefits on or before 5th April 2024, things could get complicated.  For those with an occupational ‘defined benefit’ pension in payment, it’s possible that under the old rules, you may have used all or most of your Lifetime Allowance but not all of your tax-free lump sum entitlement.  If that’s the case, and you also have pensions as yet untouched, there is a way of applying for an additional tax-free allowance certificate to which you were not previously entitled.  Care must be taken, though, because in very specific circumstances, applying for this certificate could result in a lower tax-free allowance!  

Payments to dependants and beneficiaries on death 

The second new allowance is the ‘Lump Sum and Death Benefits Allowance’.  This applies if the pension holder dies before the age of 75, and states that the maximum tax-free lump sum payment on death is £1,073,100 less any tax-free amounts paid from pensions in the person’s lifetime.  Any lump sum payment over that amount will be taxable at the recipient’s marginal rate of income tax. If you live beyond age 75, then the whole of any lump sum is taxed. 

 

Nomination of beneficiaries for death benefits 

There could be a lot of tax to pay on a large payment when the holder dies after age 75, with the highest rate of income tax being 45%.  But note it only applies to lump sums.  If the recipient chooses either a ‘dependant’s drawdown’ or ‘beneficiary’s drawdown’ fund (technically income), then they only pay tax on amounts drawn from that fund, potentially deferring, and saving a significant sum.  The catch is, this option isn’t always available. 

To have this very attractive option, the scheme must allow it (some don’t), and the recipient has to be either a dependant of the pension owner or must be specifically nominated as a beneficiary (for example your non-dependent adult children).  This nomination can be made with a pro forma from the pension provider – sometimes called an Expression of Wish or Death Benefit Nomination form.  It’s probably a good idea to check what nomination you have made, to avoid an unpleasant surprise for your loved ones. 

 

Annual Allowance for contributions 

Thankfully, the increase in the Annual Allowance was a much less complicated measure – your pensions can now receive contributions worth up to a total of £60,000 per year, rather than the previous £40,000.  With no cap on the total pension value, increasing contributions may be worthwhile, especially for higher-rate taxpayers, but note that if the value does exceed £1,073,100, you won’t be allowed any tax-free lump sum from the excess. Something to keep in mind however, for if you find yourself in certain situations, the amount you can put into your pension each year might drop from £60,000 to £10,000. It’s called the Money Purchase Annual Allowance. Also, for the high earners out there, if your income is on the higher side (we’re talking an ‘adjusted income’ over £260,000), the £60,000 you can usually tuck away into your pension each year will shrink. It goes down by £1 for every £2 you earn above that £260,000 mark.  

 

Politics 

The last point to make is that immediately after these changes were announced, the Labour Party stated that they would scrap them if they win the next election.  Should the rules be reversed, that will certainly keep the technical experts and financial advisers busy for some time to come. 

This communication is based on our understanding of the new rules and is for information purposes only, and not intended as advice. 

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