The pensions Lifetime Allowance and resulting tax charges was abolished under the UK’s 2023 spring budget. However, life is never simple with UK pensions and new tax-free limits are set to replace it.
The March budget only reduced the Lifetime Allowance charge to nil from April 6, 2023. HM Revenue and Customs (HMRC) has now published its draft legislation to fully abolish it, and this legislation also sets out how lump sums will be treated from April 2024.
With effect from April 6, 2024, two new allowances will test lump sums and lump sum death benefits against a limit.
This will add new levels of complexity to an ever-changing regime. A reform made by one government could also be overturned by a future one. With a UK general election due before too long, there is uncertainty over how this will develop.
This is draft legislation, with the final version due before Christmas. The details may change before it is finalised but, given the short time frame before implementation, it is worth seeking clarification on how the proposed rules could impact your planning, in case you wish to take action.
Lump Sum Allowance (LSA)
The Lump Sum Allowance will apply to payments made during your lifetime. The £268,275 (25% of the old lifetime allowance of £1,073,100) limit will apply to:
- Pension commencement lump sums (PCLS)
- Uncrystallised funds pension lump sums
- Trivial commutation lump sums
- Winding-up lump sums (but not transfers to QROPS)
Under current rules, you can take 25% of your pension fund – the Pension Commencement Lump Sum (PCLS) – tax free.
Under the new rules, you will need to have sufficient LSA for it all to be tax free.
Lump Sum and Death Benefit Allowance (LSDBA)
This allowance applies to lump sums paid on death and is £1,073,100 (the same as the old lifetime allowance).
Under current rules, if you die before age 75, subject to meeting the designated to drawdown rules, your beneficiaries do not pay tax on the death benefits they receive.
From April 2024, the age of death is no longer relevant. In all cases, lump sum death benefits paid from uncrystallised or crystallised benefits will only be tax-free if below the deceased’s remaining LSDBA – £1,073,100 for those with no protections minus any Lump Sum Allowance already used.
Taxation if you breach the limits
When a lump sum is paid above the limits, the excess is taxed at the recipient’s marginal rate of income tax.
For lifetime payments, you pay the tax, while for benefits paid on/after death, each beneficiary will be taxed.
No planned inflation increases
The draft legislation contains no mechanism for increasing these allowances.
It is therefore likely that, over time, the ‘today spending value’ of the tax-free proportion of your pension fund will be eroded by inflation and investment growth.
Lifetime allowance protection
The above limits apply to those without Lifetime Allowance protection.
If you have taken out protection, this is carried over. Your new Lump Sum Allowance and Lump Sum and Death Benefit Allowance will be based on your protected Lifetime Allowance.
The new rules do not have any impact on pension income; you will continue to be taxed as you are now.
If you transfer your UK pension out of the UK into a QROPS, at the time of transfer there are no UK income tax considerations.
The new rules are not set in stone and could be changed or be overturned by a future government.
When the Lifetime Allowance was abolished in March, the Labour Party were quick to pledge to reinstate it, describing the move as “a Tory tax cut for the rich”.
With the polls looking encouraging for the Labour Party and the elections having to be held by January 2025, it may not be long before the UK has a new government. There may be limited opportunity to transfer your pension out of the UK and avoid any future lifetime allowance charges.
All in all, this is a good time to consider how you may use your pension benefits in future and how any balance will be passed onto your family. Can you take steps now to protect or improve your pensions? If you plan to enjoy your retirement years in Portugal, should you leave your pension in the UK?
Pensions are highly personal. Your decisions should be based on your circumstances, objectives, risk tolerance and tax implications in the UK and Portugal. Taking the wrong approach could have unwelcome consequences, so take specialist cross-border advice covering both pensions and taxation.
This article is a brief summary of complex draft legislation. Seek clarification on how the rules would affect your pensions. Tax rates, scope and reliefs may change. Any statements concerning taxation are based upon our understanding of current taxation laws and practices which are subject to change. Tax information has been summarised; an individual should take personalised advice.
Keep up to date on the financial issues that may affect you on the Blevins Franks news page at www.blevinsfranks.com.
Dan Henderson is a Partner of Blevins Franks in Portugal. A highly experienced financial adviser, he holds the Diploma in Financial Planning and advanced qualifications in pensions and investment planning from the Chartered Insurance Institute (CII). | www.blevinsfranks.com