No More Lifetime Allowance - What It Means for You

But with the Lifetime Allowance (LTA) now in the process of being abolished, one of the main restrictions has now been removed. If you have a large pension fund (or the potential to build one up before you retire) or a defined benefit scheme, the removal of the LTA could make a big difference to your retirement plan.

A Brief History of the Lifetime Allowance
The LTA was an overall limit to the value of pension pot you could build up. When this was introduced in 2006, the LTA was £1.5 million. It rose and fell with successive governments, bringing in increasingly complex levels of protection so as not to disadvantage anyone who already had a large pot before the legislation changed.

Pension funds above the LTA would be taxed at 55% on the excess if it was taken as a lump sum, or 25% plus their marginal rate of tax if taken as income.

An LTA test would have been triggered by any of the following events:

• Taking benefits from your pension for the first time. This could mean drawing tax-free cash in isolation or combining it with income.
• Turning 75 without having taken benefits.
• Where a pot had already been ‘crystallised,’ or used to provide benefits, a second LTA test could apply at age 75 if the fund had not yet been used to buy an annuity.
• An LTA test would also apply on death before age 75 where no benefits had been taken.

Before the rules changed, the LTA was £1,073,100, where it was intended to remain frozen until 2028. From April 2023, no further LTA tax charges will apply, and from April 2024, it will be removed from the legislation.

Is Tax-Free Cash Impacted?
You can still take up to 25% of your pension as a tax-free lump sum. You may even be able to take more than this if you have a higher protected tax-free cash amount on benefits built up before 2006.

However, the monetary cap on tax-free cash that came with the LTA has not been removed. This means that regardless of the size of your pension pot, the most you can normally take in tax-free cash is £268,275. The likelihood is that this will be frozen until at least 2028 along with other tax allowances.

The difference is that rather than being taxed at 55%, any withdrawals from your pension, over and above the tax-free lump sum, are simply taxed at your marginal rate. As you have control over how and when you take benefits from your pension, this could still save significant amounts in tax.

Other Limitations on Pension Funding
With the LTA removed, retirees with large pension pots no longer have to worry about punitive tax charges when they take benefits, reach age 75, or if they die before retirement.

But there are still limitations on how much you can contribute to your pension. The main limits are:

• Anyone can contribute up to £3,600 per year, gross. This means that you pay in £2,880, and HMRC credits £720 directly to your pension.
• If you have relevant UK earnings, i.e. a salary or trading profits, you can make gross personal contributions up to the level of these earnings.
• Both personal and employer contributions are further limited by the annual allowance. This was £40,000 prior to April 2023, but has now been increased to £60,000.
• The annual allowance can be carried forward by up to three tax years, providing you were a member of a pension scheme in the relevant year. However, personal contributions are still capped by relevant UK earnings in the year they are made.
• Anyone earning over £260,000 will have a reduced annual allowance. This is reduced by £1 for every £2 over the threshold, with a maximum reduction  of £50,000. This means those earning over £360,000 can contribute a maximum of £10,000.
• The annual allowance is also reduced to £10,000 for anyone who has already taken flexible benefits from their pension.

How Will the Change Affect You?
The change will have an impact for anyone with a large pension pot.

Depending on your income and tax position, the removal of the LTA may mean it is more efficient for you to make larger pension contributions.

It’s also worth noting that pensions are not subject to Inheritance Tax. Pensions can be passed on free of tax on death before age 75. After age 75, you can pass your pension on to one or more beneficiaries and they will simply pay their own marginal rate of tax if they take money out. Pensions can be passed through successive generations in this way. The removal of the LTA may mean that people grow larger pension pots and hold on to them for longer to preserve the tax benefits.

Retirees with defined benefit pensions are likely to see the greatest advantage. Over a long career, it is not unusual for doctors or senior public sector employees to build up pensions that would have exceeded the LTA. The change may mean that more people in these roles stay in work for longer. This was, of course, the main reason given for the removal of the LTA.

Please don’t hesitate to contact a member of the team to find out more about retirement planning.