Unanswered questions around the removal of the lifetime allowance

Since the Budget back in March the pension landscape has been abuzz with discussions surrounding the removal of the lifetime allowance (LTA) – one of the thresholds that governs tax advantages on pensions. While most have welcomed scrapping the LTA there are still several questions surrounding what the post-LTA pension system will look like after April 2024, leaving experts and individuals alike grappling to understand the implications for their financial future.

What we do know is the current LTA of £1,073,100 is planned to be abolished from 6 April 2024. In 2023/24, LTA checks still need to be done, but if the allowance is exceeded there will be no LTA charge. It’s also planned that from April 2024 the tax-free lump sum or pension commencement lump sum (PCLS) will be limited to the monetary amount of £268,275 (25% of £1,073,100).

The switch to the monetary limit for PCLS rather than 25% of the available LTA presents the first question, particularly for clients with both defined benefit (DB) and defined contribution (DC) pensions. When a member takes benefits from a DB scheme, they typically have a choice of a large lump sum with a lower scheme pension or forgoing the lump sum for a higher annual pension. Currently both options use up the member’s LTA – with the scheme pension multiplied by 20 to give a capital value. With the removal of the LTA will this mean that someone will be able to take the full annual DB pension then use a DC scheme to take the maximum £268,275 tax free? Or will a new cap be introduced to somehow create a link between a DB scheme annual pension and the new monetary limit for PCLS?

There’s also a question of what will happen to uncrystallised funds pension lump sums (UFPLS). These benefits pay out a lump sum with 25% tax free and the remainder taxed as income – again limited to the member’s available LTA. Once we lose the LTA how will UFPLS work? Will they be scrapped altogether, or will new rules be introduced linking the tax-free element to the new monetary PCLS limit?

These questions and others create an unhelpful uncertainty that will not be resolved until we see the first draft of new legislation. HMRC has established a working group that will help to finalise the abolition of the LTA and draft the new legislation required, we are hopeful that the consultation on the new rules will be published ahead of the autumn giving the industry the time required to introduce the new rules and processes.

The other unhelpful uncertainty comes from politics, with the opposition party currently saying that they will, if elected, undo the removal of the LTA, leaving many to think these new rules to come will just be temporary. This speculation on future rule changes adds more questions. Will we see a new LTA protection regime? Or will clients who follow the current rules be penalised by future changes?

Hopefully we will get all the answers at some point giving that much-needed clarity.