2024 - the year of unlimited PCLS?

The consultation on the draft legislation for the removal of the lifetime allowance (LTA) has now closed. Industry has given its views and now we have to wait and see what changes – if any – are made to the clauses published so far. Of course, we’ve only seen part of the proposals: there will be more legislation to come dealing with transitional issues, and importantly, tax treatment of beneficiary’s pensions.

Some of the draft clauses we have seen include changes to the rules around the pension commencement lump sum (PCLS).

At the moment we all know that standard PCLS entitlement is 25% of the amount crystallised up to the available LTA. In the new rules, PCLS is tax free up to the permitted maximum, which is defined as the lowest of the “applicable amount”, the available Lump Sum Allowance (LSA) and the available Lump Sum and Death Benefit Allowance (LSDBA). In the SIPP world the applicable amount is one third of the amount used for drawdown or annuity purchase.

This means we have new terminology – 1/3 of the amount put into drawdown up to LSA/LSDBA replacing 1/4 of amount crystallised up to LTA – but no real change in practical terms.

Until you get to the bit where it says that anything above this is subject to income tax. This might not sound significant at first glance, but this is a big change from the current position where excess PCLS payments are unauthorised payments with penal charges, so no scheme is likely to allow this.

In reality for SIPP customers, since 2015 they’ve had the option of taking lump sums above the level of PCLS in the form of drawdown income with the only consequence being income tax payable (within the LTA).

However, when you start to think about defined benefit (DB) schemes this would be a significant change.

If there is no pension income being taken then the permitted maximum tax-free PCLS will be zero – but importantly PCLS could still be paid out under the new rules. Effectively you could withdraw the whole DB scheme as a PCLS payment, albeit subject to income tax.

There are scenarios where this may be attractive – for example if the LSA has already been used up in other schemes so no more tax-free cash is available anyway. For a client with a small DB scheme and plenty of drawdown elsewhere, taking the DB pot as a one-off taxable lump sum could be seen as a tidying up exercise.

Some with small DB schemes just over the advice threshold (£30,000) may want to access their pension pot but are unwilling to pay the advice cost. They may be prepared to pay income tax to get the whole lot out, rather than have a minimal scheme pension paid for years.

Whether this was intended or not, it would be a significant change in policy and potentially damaging to some of the safeguards put in place for those with DB schemes.

Only time will tell if this small part of the draft rules remains unchanged come April 2024.