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Did you know that there was a “cap” on how much value you could hold in the pension, tax-free, in 2022? This was called the Lifetime Allowance and, as of 6 April 2023, the charge has been abolished by the Chancellor.
In the 2023-24 tax year, you can now take pension benefits in excess of the Lifetime Allowance without worrying about a 55% tax charge for a lump sum (or 25% if taken as income). Yet what does this mean for your pension plan?
Below, our Burnley financial planners explore the implications of the Lifetime Allowance abolition. Please contact us if you want to discuss your financial plan with an experienced financial planner here in Padiham.
What is the Lifetime Allowance?
The Lifetime Allowance previously set a tax-free limit on an individual’s pension benefits (across all of their schemes). In 2023-24, you could store up to £1,073,100 in your schemes without worrying about getting taxed on withdrawals.
As of 6 April 2023, however, the Lifetime Allowance no longer applies. This means that an individual could, for instance, save £2m into pensions and still enjoy the tax benefits.
However, the tax-free limit on lump sums still applies. The maximum value is either 25% of £1,073,100 or 25% of the total capital value of your pension(s). Any lump sums taken above these limits will be taxed at your marginal rate of income tax.
Why does the Lifetime Allowance abolition matter?
The Chancellor abolished the Lifetime Allowance, at least partly, to simplify the tax system for pensions but also to encourage more senior NHS workers (e.g. GPs) to stay in the workforce longer. Many doctors were retiring early to avoid large tax bills on their pensions and the government is keen to avoid this.
Naturally, the removal of the Lifetime Allowance (LTA) means that someone could potentially save more into pensions and enjoy a better future retirement lifestyle.
This is helped by the extension of the annual allowance by 50% to £60,000. This is the maximum you can save into your pensions each tax year in 2023-24 (or, up to 100% of your earnings – whichever is lower).
The LTA abolition could, also, impact estate planning. This is because pension pots are exempt from inheritance tax (IHT). So, if more wealth can be stored in an individual’s pension, then this could be a valuable tool to help mitigate IHT when passing down wealth to loved ones.
What about death benefits?
There is an important, little-known change about pension payments to beneficiaries following the Spring Budget. Whilst pensions sit outside of IHT in 2023-24, they can still bear upon your beneficiaries’ income tax bill.
If you die after age 75, then any pension benefits received by beneficiaries will fall under their marginal rate of income tax. If you die before age 75, however, the rules are more complex.
In this case, benefits are paid out to beneficiaries, tax-free, if they are paid out within two years of the date when the scheme discovers the individual’s death.
If lump-sum death benefits within this two-year period exceed the deceased person’s LTA (£1,073,100), however, then they will be subject to the beneficiary’s marginal rate of income tax.
In summary, the abolition of LTA does not mean that you can pass down lots of wealth via pensions without tax implications. A financial planner can help you craft an estate plan which accounts for these complex rules.
What is the future of the Lifetime Allowance?
It is important to recognise that tax rules change over time. Indeed, the Labour Party has said it will reverse the Lifetime Allowance abolition if it wins the next general election (but carving out more specific rules for NHS doctors).
This makes long-term pension planning more difficult. For instance, it would be unfortunate if someone saved over £1,073,100 in their pension(s) and the LTA was re-introduced, leading to tax charges on withdrawals over the LTA.
If the Labour Party wins the next general election, certain individuals could potentially avoid this outcome by retiring early. However, this would not be a light decision.
For instance, taking pension benefits can trigger the Money Purchase Annual Allowance (MPAA) rules. In 2023-24, this reduces the maximum annual allowance from £60,000 to £10,000, thus limiting how much you can contribute to your pension(s) whilst enjoying tax relief.
What about Lifetime allowance protections?
The standard LTA was lowered on 6 April 2016. Certain individuals were able to protect their LTA by applying for two types of protection – Individual Protection and Fixed Protection.
Those who did this may be able to now accrue new pension benefits in 2023-24 and enjoy new rights (e.g. joining new pension arrangements) without losing protection.
For instance, you might have asked an employer to exclude you from the workplace pension scheme to avoid tax charges on your pension. You may now be wondering whether to rejoin.
Speak with a financial adviser to explore your options using the best available information.
Invitation
If you are interested in starting a conversation about your own financial plan or investments, then we’d love to hear from you. Please contact us to arrange a free, no-commitment consultation with a member of our team here at Elmfield Financial Planning in Padiham, Burnley, Lancashire.
Reach us via:
T: 01282 772938
E: info@elmfieldfp.co.uk
