Since 6 April 2023 no lifetime allowance (LTA) charges apply. All other aspects of the LTA framework have remained in place. However, where there is an excess, either a nil charge applies or the excess is subject to income tax at the individual’s marginal rates.

HMRC are now working on trying to deliver the more complex task of abolishing the LTA altogether from 6 April 2024.

The removal is complicated by the limits on tax-free cash and other tax-free lump sum payments, such as death benefits for those who die under the age of 75. The tax-free element of these payments are currently limited and calculated by reference to the individual’s available LTA. If the LTA is abolished, something else needs to be introduced to replace it.  

In July 2023, HMRC issued a policy paper, some draft legislation and Pension Schemes Newsletter 152 all covering the proposed amendments and their progress to date. Together, they give a good idea of how the process may work but there are still several key issues to resolve and further clarity is required.

Limits on tax-free lump sums

The plan is to introduce two limits on pension payments that can be made free of tax:

• An overall limit of lump sums and lump sum death benefits of £1,073,100.
• A tax-free cash limit of £268,275. This will count towards the overall limit above and will include the tax-free element of uncrystallised funds pension lump sums.

Anything above these limits will be paid subject to income tax at the member or beneficiary’s marginal rates. 

Where LTA protections apply, these will increase the limits in the same way as they do currently. 

Valuations

At high level, the limits are probably what most people expected. However, it is not clear how any previous tax-free cash payments will be valued and accounted for. The policy statement says that HMRC’s intention is not to change the approach that schemes currently take to valuing benefits. However, as the benefits have all previously been calculated by reference to the LTA, it is not clear how schemes will operate the new rules. 

The limit will also include small pots, winding up lump sums and trivial commutation payments which seems an unnecessary complication and one area that HMRC may review.

Hopefully, the valuation issues can be clarified but it is going to be difficult to achieve and implement any changes by 6 April 2024.

Death benefits

The bigger issues appear to be around the potential change in death benefits. Whilst there is nothing in the draft legislation, the policy paper states that death benefits currently paid in the form of income “will no longer be excluded from marginal rate income tax under ITEPA, with effect from 6 April 2024”. Whilst some may have expected the tax-free amount to be limited to £1,073,100, it will come as a shock to many that potentially all death benefits paid as income will now become taxable. The change doesn’t seem to match the policy intention and may well be a mistake. 

Another change in relation to death benefits relates to crystallised funds lump sum death benefits. Currently, these are not tested against the LTA and, so, any crystallised funds paid as a lump sum would be free of tax if the member dies under the age of 75. The proposed changes (if enacted) would mean that all lump sum death benefits will be tested against the £1,073,100 lump sum limit and any excess will be subject to income tax. The logic of this change is that the crystallised funds will not have previously been tested once the LTA is removed.  

Summary

In the current tax year, we still have the LTA framework in place and no LTA charges apply. It is not a perfect situation but is a system that works, one that schemes can implement and it meets the overall policy objective. It was always going to be a much more difficult task to remove the LTA altogether. We are now only seven months away from the next tax year and it may be better to delay the removal of the LTA rather than introduce new rules that are both difficult to administer and introduce new forms of unexpected taxation.    

We will provide further updates as and when we get more clarity.

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