- HMRC has confirmed that the lifetime allowance will be scrapped from pension tax rules with effect from 6 April 2024
- In a policy paper published today, it has outlined how the new regime will work
- In a U-turn to previous proposals in the policy paper published in July, today HMRC confirms income withdrawals taken by beneficiaries where the member died before age 75 will not be taxed
- The Autumn Finance Bill – expected to be published soon – will give the full details of the change
- With just 90 working days until the new rules apply, there is potential to create problems for consumers, causing confusion and pushing them to make rushed decisions
Rachel Vahey, head of policy development at AJ Bell, comments:
“The government has confirmed the lifetime allowance will be scrapped from pension rules from April next year.
“Crucially, this year the lifetime allowance remained in place but with no charges applied, meaning a future government could re-introduce the lifetime pension cap relatively easily. Passing legislation to abolish the lifetime allowance altogether makes it far more difficult for policymakers to reverse the rules again, as Labour has pledged.
“The move makes pensions more tax efficient for thousands of higher earners who had built up pension pots worth £1,073,100 or more.
“It also means those who feared hitting the lifetime allowance can resume contributions and keep building their pension pot.
U-turn on pension death tax
“In a welcome move for pension savers, HMRC has U-turned on its previous plans to create a new pensions death tax for those taking income withdrawals.
“Under current rules, if you die before age 75 your beneficiaries can inherit your defined contribution (DC) pension completely tax-free if it is under your lifetime allowance. HMRC has announced that, contrary to previous plans, this situation will continue.
“This is good news for pension savers. Creating a new stealth tax would have been a massive shift in policy hitting hard the beneficiaries of pension savers who die early.
“It was hoped scrapping the lifetime allowance may have made pensions simpler to understand, but the new rules are complicated and replace one allowance with two new ones.
“Nonetheless, today the government confirmed a start date of 6 April 2024, leaving just over 90 working days until the new rules kick in.
“Although the policy paper takes us one step closer, we won’t fully understand the new rules until we see the draft legislation which is to be published in the Autumn Finance Bill.
“Worryingly, even once Royal Assent is given, HMRC reserves the right to make changes to the rules through secondary legislation up to April 2026 rather than including them in a new Finance Bill.
“This suggests HMRC may be worried the new rules are not yet fully waterproof and leaks may emerge where it doesn’t work in the way HMRC intended.
“An accelerated implementation period may cause problems too. Achieving good consumer outcomes is at the forefront of everything advisers and providers do. By pushing the new rules in before the general election, the government has prioritised its legacy over good consumer outcomes. Instead it could create consumer confusion and the danger they rush to make decisions which are not in their best interest.”
Background:
Last tax year (2022/23), the lifetime allowance was £1,073,100, with the maximum amount of pensions tax-free cash someone can build up in their lifetime usually limited to 25% of this, or £268,275. Any excess above this lifetime allowance was subject by HMRC to a lifetime allowance charge of either 25% (if taken as income) or 55% (if taken as a lump sum).
In the Spring Budget, chancellor Jeremy Hunt said the government intended to abolish the lifetime allowance altogether. Changes brought into force in April for this year (2023/24) retained the lifetime allowance in the tax system but removed the lifetime allowance charge.
The lifetime allowance will be fully removed from the pension tax rules from April next year, leaving a tax regime where consumers can take as much income as they want from their pension (albeit still subject to income tax) and checks will only be made on lump sums taken.
Two new allowances will be created under the plans:
- An individual ‘Lump Sum Allowance’ set at £268,275 (a quarter of the current £1,073,100 lifetime allowance) measuring the tax-free cash taken over someone’s lifetime.
- An individual ‘Lump Sum and Death Benefit Allowance’ set at £1,073,100 – incorporating both tax-free lump sums someone takes while alive, plus any serious ill health lump sum and lump sums paid out when they die.
If anyone goes over these allowances, then the excess will be taxed in the same way as income.
Pension death benefits explained
Since the removal of any lifetime allowance charge from last April death benefits were taxed as follows where the member dies before age 75:
- Pensions paid as income completely tax-free, regardless of the size of the fund
- Pension paid as a lump sum are tax free, with any excess over the saver’s lifetime allowance taxed as income
HMRC has confirmed this current situation is to continue.
Switching regimes
There will be some people who have already taken some of their pension before 6 April 2024, but still have some untouched funds. Pension schemes and advisers are eagerly awaiting ‘transitional rules’ for these people explaining how to measure benefits taken over the two different tax regimes. The draft legislation published in July only had ‘TBC’ (to be confirmed) written under the heading of transitional arrangements.
It's important these rules are kept as simple as possible. Advisers and their clients only have a few weeks to make the best decisions for clients’ financial futures, so the rules need to be easy to understand and appropriate.
