In more detail

Budget 2023

The Chancellor announced a number of significant changes to the pensions taxation regime in his Spring 2023 budget ("Budget"), of which the abolition of the lifetime allowance (LTA) was the most headline grabbing. The changes were primarily aimed at alleviating workforce pressures in the NHS, although the Government is not limiting the changes to NHS employees and the changes impact higher paid employees more generally.

The Government confirmed at the time of the Budget that the changes to the LTA regime would be implemented in two phases. Further detail summarising each of the phases is below. Broadly, the first phase, from 6 April 2023, saw the removal of the LTA charge (a tax charge of 55% levied on pension saving in excess of the LTA). The second phase, currently expected to be implemented from 6 April 2024, will remove the LTA itself.

First phase of changes to the LTA: from 6 April 2023 to 5 April 2024

During the first phase:

• The LTA of GBP 1,073,100 remains in place. Administrators must continue to test against the LTA on benefit crystallisation events and provide BCE statements. However, where individuals exceed the LTA, an LTA charge will no longer apply.

• In the absence of the LTA charge, the taxation of certain lump sums (serious ill-health lump sums, defined benefits lump sum death benefits, lifetime allowance excess lump sums and uncrystallised funds lump sum death benefits) has also changed. Where previously these types of authorised lump sum would have been impacted by the LTA charge at 55% in relation to any excess over the LTA, any excess is now taxed at the recipient's marginal rate.

• No new charging provisions were introduced in relation to authorised pensions. The effect of this, in conjunction with the removal of the LTA charge, is that the authorised pensions (including any excess over the LTA) are subject (as previously) to tax at an individuals' marginal rate.

• Changes were made allowing individuals with LTA protection to be able to continue to save into a registered pension without losing the benefit of their protection. After 6 April 2023, the main benefit to having LTA protection is an entitlement to a higher tax-free lump sum based on what they were entitled to prior to that date.

For more detail on changes in the first phase, including other changes to the pensions tax regime announced in the Budget (e.g., changes to the level of annual allowance) see our alert here.

Second phase of changes to the LTA: Expected from 6 April 2024

The Government recently published draft legislation implementing the abolition of the LTA. HMRC also published an accompanying policy paper. The Government invited comments on the draft proposals, and it is possible that we could see some changes to the draft proposals before they are formally published in the form of a Finance Bill.

Whilst the first stage of implementing the changes was relatively straightforward, the removal of the LTA from the current tax framework is a far more complex undertaking, reflected in the very large number of draft provisions. Key points to note in relation to the second phase draft provisions are set out below.

• All references to the LTA will be removed from legislation. In its place two new allowances will be introduced: (i) an individual's lump sum and death benefit allowance and (ii) an individual's lump sum allowance.

• The new individual's lump sum and death benefit allowance will limit the total amount of lump sums and lump sum death benefits (but not pensions) which can be taken tax free by an individual to a maximum of GBP 1,073,100 (i.e., equivalent to the current LTA). All authorised lump sum and lump sum death benefits which are paid to or in respect of an individual (across all registered pension schemes of which the individual is a member) will be tested against this allowance. The allowance will be reduced each time an individual becomes entitled to an authorised lump sum or a person becomes entitled to an authorised lump sum death benefit in respect of that individual (the amount of the deduction in each case being the non-taxable amount in relation to that payment).

• The new lump sum allowance will be set at GBP 268, 275 (25% of the current LTA). This will set a further limit on the total value of tax-free cash which can be taken in relation to certain specific authorised payments (pension commencement lump sum (PCLS), uncrystallised funds pension lump sum, trivial commutation lump sum and winding up lump sum). Again, the intention is to maintain the amount of tax-free cash that individuals can receive at the level which currently applies.

• Individuals with LTA protection: both the new allowances will be increased for individuals with LTA protection. Broadly, the effect of the draft provisions will be to maintain the entitlements which such individuals had prior to the abolition of the LTA relating to tax free cash.

• Lifetime allowance excess lump sums to be abolished: although most authorised lump sums (and authorised pensions) will continue (with some consequential changes to reflect the abolition of the LTA), lifetime allowance excess lump sums will be abolished entirely. Previously (and currently during the first phase of the changes), these allow any benefit entitlement crystallising over and above the member's available LTA to be paid as a lump sum if certain conditions are met.

• Tax treatment of amounts in excess of the new allowances:

• Pension income: will not count towards either of the new allowances. This means that the tax treatment for pensions income will effectively remain the same as during phase one – with the whole amount being taxed at an individual's marginal rate, and with no additional tax payable on what would otherwise have been an excess over the new thresholds.

• Authorised lump sums and authorised lump sum death benefits: generally, any excess over the new allowances will be charged at the recipient's marginal rate. Again, this is consistent with the approach taken during the first phase. The higher (55%) special lump sum death benefit charge which currently applies (and which applied prior to 6 April 2023) will, however, continue to apply to any excess over the new lump sum and death benefit allowance in relation to lump sum death benefits in certain circumstances.

• Additional PCLS flexibility: the new regime does not, under the current draft provisions, place any limit on the amount of authorised lump sums and lump sum death benefits which can be taken; it only places a limit on the lump sum amounts which can be taken tax-free. Previously (and also currently during the first phase of the changes), one of the conditions which a PCLS must meet in order for it to quality as an authorised payment is for the individual to have sufficient LTA. Any excess does not qualify as a PCLS and therefore cannot be paid as an authorised payment. This restriction would be removed as part of the current proposals, meaning that, subject to the scheme rules, individuals would not face any limit on the amount which could be taken as a PCLS under the tax legislation, but the excess would be taxed as an individual's marginal rate. We comment on this further below.

• Change to tax treatment of unused funds paid to dependants out of uncrystallised funds? Prior to 6 April 2023 (and also during the first phase of the changes), if an individual died before age 75 leaving uncrystallised funds a lump sum could be paid to a dependant out of drawdown funds, or used to buy an annuity for the dependant, free of income tax if certain conditions were met. HMRC has indicated that it is intending to change this position from 6 April 2024 and make these subject to income tax at the recipient's marginal rate. The draft provisions do not, however, currently reflect this policy intention. HMRC has invited comments on this area, and it is not clear at this stage whether the policy intention will be reflected in legislation in due course, or HMRC will re-consider its policy in this area.

• Benefit crystallisation events: all the current benefit crystallisation events are being abolished. Administrators will, however, still need to keep track when a wide range of benefits crystallise, in order to be able to determine how much of the new allowances remain available to individuals and, consequently, how much income tax they are required to deduct. It is not yet clear exactly what requirements will be placed on administrators in relation to this, although some new kind of record keeping will be necessary. This is an area where further details may emerge in due course.

Comments

Most of the changes implementing the abolition of the LTA follow fairly logically from the changes which were implemented in the first phase. Aspects where we are likely to see further discussion - and where potentially we could see some further changes - are in relation to removal of the restriction on the amount of PCLS, and the possible new charge to income tax in relation to lump sums and annuities for dependants purchased from uncrystallised funds.

Some trustees may have concerns about members commuting large amounts of DB pension for a lump sum.

Next steps

• Trustees should start familiarising themselves with the changes and start considering what actions will be needed for their particular scheme. Members will need to be informed of the changes, although the content and timing for this need to be considered carefully given that the legislation could change before it is enacted.

• Scheme rules and associated member communications such as booklets will need to be checked to see if they need updating in light of the changes.

• Trustees should discuss the changes with their administrators and to check how they are placed to update their processes to reflect the new requirements. The timing for doing this could be a challenge – particularly as much of the detail about record keeping and communicating with members in relation to the new allowances is still awaited, including transitional provisions dealing with arrangements for individuals who have already used up some but not all of their LTA under the current regime.

• Employers may wish to consider whether the changes have consequences for any other benefit arrangements which interact with the LTA, for example excepted group life policies and cash in lieu of pension arrangements.