Changes to transitional pension tax rules

The new pension tax rules have been in place for more than six months now and the industry collectively breathed a sigh of relief when the Chancellor chose not to tinker with them further in the recent Autumn Budget.

There were several serious errors in the Finance Act 2024 abolishing the lifetime allowance, which resulted in HMRC warning that some pension scheme members may need to wait before accessing or transferring their pension. Regulations to correct these issues were finally laid in October. They came into force on 18 November 2024 and are backdated to 6 April 2024.

In these regulations, HMRC has also taken the opportunity to fine tune some of the rules that, whilst working as originally intended, could have been improved. This includes changes to the transitional rules impacting those who accessed a pension before 6 April 2024.

Transitional rules up to 17 November 2024

Transitional rules were introduced from 6 April 2024 for individuals who had used up some, or all, of their lifetime allowance before that date. These rules calculated a reduction in the available amounts of their new lump sum allowance (LSA) and lump sum and death benefits allowance (LSDBA) based on the amount of lifetime allowance the individual had used up.

Members could choose whether they want a standard transitional calculation to determine their available allowances, or if they would instead rely on a transitional tax-free amount certificate.

The standard transitional calculation was intended to be suitable for most people. It reduced the LSA by 25% of the lifetime allowance previously used. This included lifetime allowance deemed to be used in respect of pre-commencement pensions (pensions accessed before 6 April 2006), and any used up at age 75 under the old benefit crystallisation events (BCEs) 5, 5A or 5B.

For example, if 60% of the lifetime allowance had been used up by 5 April 2024, the LSA would be reduced by 25% of 60% of £1,073,100. This reduced the LSA from £268,275 to £107,310.

There was also a calculation for reducing the available LSDBA. This was either:

• 100% of all lifetime allowance used if any serious ill health lump sums were paid before age 75;
• 100% of all lifetime allowance used if a lump sum death benefit was paid in relation to members who died before age 75; or
• 25% of the lifetime allowance used.

In contrast, a certificate calculated the reduction to both allowances by aggregating the actual amounts of tax-free cash taken at each BCE up to 5 April 2024. Where the member started taking pension benefits before the introduction of the lifetime allowance on 6 April 2006, and went on to have a BCE before 6 April 2024, a certificate would assume 25% of the lifetime allowance reduction calculated at the first BCE was taken as a tax-free lump sum.

A certificate had therefore been a useful tool for those who took less than 25% tax free cash at their BCEs to ensure their allowances were calculated accurately and they didn’t miss out on tax-free cash they would have been entitled to under the previous regime.

Standard transitional calculation – age 75

From 18 November 2024, the standard transitional calculation now excludes lifetime allowance used up at the BCEs at age 75, as long as the member did not take any subsequent tax-free cash before 6 April 2024.

This will mean fewer over 75s may need to apply for a certificate, as the standard transitional calculation may now be more suitable for them.

However, those who did go on to take tax-free cash after their 75th birthday will still have their allowances calculated using the original version of the transitional calculation and may still benefit from a certificate.

Example

Anne turned 75 before 6 April 2024. She used 40% of her lifetime allowance of £1,073,100 in May 2021, and a further 40% when her remaining uncrystallised funds were tested on her 75th birthday. She does not have any transitional protections.

Using the original standard transitional calculation, Anne’s remaining LSA would be reduced by £214,620 (80% of £268,275), leaving her with £53,655.

Under the new standard transitional calculation, Anne’s lifetime allowance used when she turned 75 would be ignored. Her LSA will now only be reduced by £107,310 (40% of £268,275), leaving her with £160,965.

If Anne had taken PCLS after her 75th birthday she wouldn’t benefit from the new calculation. But she could still apply for a certificate, which may benefit her.

The good news is that this revised calculation will likely reduce the number of people who need to apply for a certificate. But as is often the case when the rules change, there are both winners and losers.

A certificate has the potential to create a better outcome for those for whom the standard transitional calculation doesn’t work well. The decision to apply for a certificate is irreversible, and it must be relied on once issued. It can only be cancelled if the transitional amounts it confirms are inaccurate.

Unfortunately, from 18 November there will be a small group who may find that a certificate is no longer the best option for them.

Example

Nathan used up 60% of his lifetime allowance of £1,500,000 in November 2014. He does not have any transitional protection. At the time he received £225,000 as PCLS.

He turned 75 in January 2023, with his uncrystallised funds using up his remaining 40% lifetime allowance.

As he had used up 100% of his lifetime allowance, Nathan would have been left with no LSA available and would have lost the ability to take tax-free cash from his remaining pension funds. He therefore applied for a certificate, so his LSA was only reduced by £225,000 to £43,275.

If Nathan had waited until 18 November, he would have been subject to the new standard transitional calculation. This would have excluded the lifetime allowance used up at his age 75 test, and his remaining LSA would have been calculated as 25% of 60% of £1,073,100. His LSA would have been reduced by only £160,695 to £107,580.

However, there is nothing Nathan can now do to get the higher amount of tax-free cash. He cannot cancel the certificate as the amounts used were correct at the time of applying.

This is an unfortunate consequence of the overly ambitious timescale for abolishing the lifetime allowance and the unexpectedly lengthy wait between the new regime being implemented and the amending regulations coming into force. But that will be no comfort for those who will feel they’ve lost out due to this change.

Going forward, when deciding whether a certificate is the best option it will be important to understand which version of the standard transitional calculation would otherwise apply.

Standard transitional calculation – lump sum death benefits

The new regulations also include a more minor change to the standard transitional calculation in respect of the LSDBA. The calculation has been tweaked so that the LSDBA will be reduced by 100% of all lifetime allowance used only where a serious ill health sum was paid before age 75, or if either an uncrystallised funds lump sum death benefit or defined benefits lump sum death benefit was paid in relation to members who died before age 75 and within the relevant two-year period.

This limits the situations where 100% of lifetime allowance use is deducted from the available LSDBA. This won’t impact many people but is a welcome change as it more closely matches treatment prior to 6 April 2024 where only these lump sum death benefits would have been tested against the lifetime allowance.

All of these changes are effective from 6 April 2024, so those who have taken tax-free cash since that date may find their available allowances are slightly different than first thought and may want to contact their scheme to recalculate this.

Transitional tax-free amount certificates

The Finance Act 2024 incorrectly excluded any tax-free cash taken after age 75 in calculating the available LSA when an individual applied for a certificate. HMRC recommended that pension schemes could take a pragmatic approach and include these lump sums in their calculations immediately to ensure certificates would be valid. However, some individuals may have chosen to wait for the new regulations before applying for a certificate, so now would be a good time to revisit this.

The regulations also impose a new requirement on members, and personal representatives of deceased members, who have received a certificate to provide a copy of it to all their “certification administrators” – this means all registered pensions schemes they (or the deceased) are a member of and all insurance companies they receive an annuity from. The copy certificate must be provided within 90 days of receiving it, or before the individual’s first relevant benefit crystallisation event (RBCE). Similarly, there is also a new requirement to inform all the individual’s certification administrators within 90 days when a certificate is cancelled.

Some individuals will already have had a certificate for more than 90 days, or already had their first RBCE. Although the regulations are effective from 6 April 2024, these obligations only begin from 18 November 2024, so there will still be time to comply.

For personal representatives of deceased individuals, there are also changes to the deadline to apply for a certificate. Currently, a certificate must be applied for before the individual’s first RBCE, but this deadline will be extended in respect of deceased members to 31 October following the end of the tax year in which a relevant lump sum death benefit is paid. This removes some pressure from personal representatives and gives time to understand whether a certificate would be beneficial.