Will the removal of the pension lifetime allowance simplify pensions?

The Chancellor’s announcement in the Spring Budget that he intends to abolish the lifetime allowance (LTA) from April 2024 at first looks like a big step in simplifying pension tax rules. The LTA was introduced originally to limit the amount of tax relief that high-earning individuals could benefit from within their pension schemes. Over the years, the LTA has been subject to changes and adjustments due to evolving economic and political conditions. The changes aimed to strike a balance between encouraging retirement savings and managing the cost of pension tax relief for the government. The LTA is currently set at over 40% less than its highest point in the 2010s, so many people who had built up pension funds that they wouldn’t consider excessive found themselves paying tax charges in retirement.

One of the main arguments in favour of removing the LTA is the complexity it adds to pension planning. The LTA is just one of many rules and restrictions that individuals need to navigate when planning for their retirement. The existing pension rules, including Annual Allowance and Tapered Annual Allowance, have made pension planning increasingly convoluted, especially for high earners. Removing the LTA should, if done in a considered way, streamline the process and make it easier for people to understand how much they need to save for their retirement, without the fear of additional tax charges.

The first measures are already in place, with the Finance (No. 2) Act 2023 removing the LTA tax charges from 6 April 2023, meaning now there are no tax consequences for exceeding the LTA unless you take the excess as a lump sum, which is now subject to Income Tax.

Just removing the LTA charge does a good job of simplifying the system, but the Chancellor pledged to abolish the LTA completely so further significant legislation changes are still needed to make good on that promise.

We have now had the first glimpse of what the proposed revisions to the legislation will look like, with the publication of draft legislation for next year’s Finance Act and a policy paper from HMRC. In the new regime most of the benefit crystallisation events (BCEs) have been removed and there will be no tests when someone takes an income from their pension. Any lump sums taken from a pension will be tested against two new lifetime limits, the Lump Sum Allowance (LSA) and the Lump Sum and Death Benefit Allowance (LSDBA).

The LSA is to be set at £268,275 and will limit any PCLS taken and the tax-free parts of other lump sums such as UFPLS payments. The LSDBA will be £1,073,100 and will measure (again) lump sums already tested by the LSA, as well as any serious ill health lump sums and lump sums paid on death. Any payments over the LSDBA will be subject to Income Tax at the individuals’ or beneficiaries’ marginal rate.

The introduction of two novel allowances designed to replace the existing LTA, which will mostly put people in the same tax position as they were before any of the changes, might not necessarily yield a straightforward simplification of the overall pension tax framework. Indeed, one could make the case that the introduction of two new limits accompanied by unfamiliar acronyms would only serve to create more confusion.

The abolition of the LTA ought to mark a stride towards simplicity, but altering pension tax policy will always pose a challenge due to the inherent complexity of the system.