The Abolition of the Lifetime Allowance in 2024: A Short Guide

In the Spring Budget of 2023, it was announced that the Lifetime Allowance (LTA) would be abolished. This would remove one of the barriers to building up large pension pots, and in particular, was designed to keep more senior public sector employees in the workplace.

With the removal of the LTA being written into law from April 2024, we explain below what this means and how you might be affected.

A Brief History of the Lifetime Allowance
The LTA was introduced in 2006 and was intended to place an overall cap on the amount of pension benefits a person could accrue in a lifetime. At the time, the LTA was £1.5 million, but this went up and down depending on government sentiment at the time, eventually settling at £1,073,100 before its removal was announced. Anyone impacted by the reduction to the LTA at various points could apply to HMRC for protection.

Pension pots would be tested against the LTA on any of the following events:

• ‘Crystallising’ your pension by taking benefits for the first time. This could mean withdrawing a 25% tax-free lump sum, with or without income.
• Reaching age 75 without having taken benefits.
• Where a pension pot was used to provide a drawdown income, a second LTA test would be applied at age 75 to assess the value added by investment growth.
• On death before age 75 where the deceased person had uncrystallised pensions.
• Moving the pot to an overseas pension scheme.

If a pension pot exceeded the LTA, the excess would be taxed at 55% if taken as a lump sum, or 25% (plus the relevant rate of income tax) if taken as an income.

What is Changing?
The tax impact of the LTA was removed from April 2023, meaning that anyone triggering one of the above benefit crystallisation events in the current tax year would not pay the tax.

The change is due to be written into law from April 2024 via a Finance Bill. This will remove the LTA from legislation.

An important caveat is that the limit on tax-free cash will remain in place. This is currently £268,275, or 25% of the former LTA. This is expected to remain frozen until 2028, as was the original plan for the LTA. Members with HMRC protection or scheme specific protection may be eligible for a higher tax-free lump sum. However, any excess benefits will simply be taxed at the normal rate for income.

What Does This Mean for You?
The new measures will benefit anyone with a large pension pot. If you are planning to retire, and already have a pension fund of over £1.073 million, there is a good chance you will save tax.

If you are many years away from retirement, the removal of the LTA means that you can save significantly more into your pension without worrying about tax penalties when you retire.

The change will have a major impact on generational wealth planning. Pensions can be passed on to beneficiaries free of tax on death. If you are over age 75, tax will be payable at the beneficiaries’ marginal rate, but only when they make withdrawals. The removal of the LTA means that larger pots can be passed on to the next generation without restriction – in fact, more people are likely to use this as a primary reason to fund pensions.

Members of generous final salary or career average pension schemes will likely see the most benefit. The amount tested against the LTA was the amount of annual income multiplied by 20 plus any additional lump sums. This means that someone with an annual pension of £50,000 per year (possibly with tax-free lump sums and a few smaller pension pots in addition) would be in danger of breaching the LTA. While this sounds like a lot, it was a reality for many people earning £75,000 or over, including doctors, senior police officers, and some members of the civil service. Additionally, members of defined benefit schemes have less flexibility over how and when to take their pension benefits, which means that options to reduce the impact of the LTA were limited.

Members of these schemes are likely to see the most benefit in the shorter term (and were the main target of the legislation), although this may equalise as more people built up larger personal pensions and defined benefit schemes become less common.

Other Limits on Pension Funding
Of course, the LTA is not the only limit on pension funding, and breaching any of the following could also result in tax implications:

• You can personally contribute the higher of £3,600 or your gross relevant earnings (salary or trading profits) to a pension. As the contribution is made net, a gross payment of £3,600 will only cost £2,880 out of your pocket.
• This is further limited by the annual allowance, which is currently £60,000. This covers personal and employer contributions. So if your employer overfunds your pension, you are still taxed as if you were paid the same amount in your salary. Additionally, the money is then tied up in a pension, to be taxed a second time when you take benefits.
• If you have been a member of a pension scheme but not used your full annual allowance for the previous three tax years, you could potentially carry forward allowances from previous years. However, if making the contribution personally, you need to have the relevant earnings to receive full tax relief.
• Anyone earning over £260,000 will have their annual allowance reduced by £1 for every £2 of earnings over the threshold. The maximum reduction is £50,000, taking the annual allowance to £10,000 for anyone earning £360,000 or over.
• The annual allowance may also be reduced to £10,000 for anyone who has taken flexible benefits from their pension.

If you are a higher earner or have a large pension pot, you may benefit from advice to determine the best way to achieve your goals, save tax, and pass on more of your wealth to your loved ones.

Please do not hesitate to contact a member of the team if you would like to find out more about retirement planning.