What changes have been made to the lifetime allowance and annual allowances?
In the Budget on 15 March 2023, the Government announced several changes to the annual allowance, lifetime allowance and tax-free cash. This was followed by the Finance (No.2) Bill 2023 which once it becomes an Act will put some of these changes into legislation from 6 April 2023. Other changes announced in the Budget will not take effect until the 2024/25 tax year, and further information is expected on these later in the year.
- Annual allowance is now £60,000.
- Money purchase annual allowance is now £10,000.
- There will be no lifetime allowance charge in tax year 2023/24.
- The lifetime allowance will be abolished from 6 April 2024.
- Maximum tax-free cash will be frozen at £268,275 from 6 April 2024.
What are the changes from 6 April 2023?
The changes from 6 April 2023 are:
- The annual allowance increased from £40,000 to £60,000.
- The money purchase annual allowance increased from £4,000 to £10,000.
- The adjusted income for the purpose of the tapered annual allowance increased from £240,000 to £260,000.
- There is no lifetime allowance charge.
- Taxation of any lifetime allowance excess lump sum, serious ill-health lump sum, defined benefits lump sum death benefit and uncrystallised funds lump sum death benefits above the lifetime allowance changed from a 55% tax charge to taxation at an individual’s marginal rate of income tax.
- An individual who applied for enhanced protection or fixed protection 2012, 2014 or 2016 before 15 March 2023 and had received a valid certificate/reference number can have a ‘protection cessation event’ on or after 6 April 2023 and will not lose their protection.
- Those with enhanced protection and a registered tax-free cash percentage shown on their enhanced protection certificate will still be entitled to a higher tax-free cash but it will be based on the lower of the value of their pension fund on 5 April 2023 and the date they take their benefits.
You’ll find more detail on these changes below.
What has not changed this tax year (2023/24)?
The following has not changed in tax year 2023/24:
- All existing rules for calculating tax-free cash remain for tax year 2023/24.
- Lifetime allowance checks still need to be done at benefit crystallisation events.
What additional changes do we expect in tax year 2024/25?
The additional changes expected from tax year 2024/25 are:
- The lifetime allowance will be fully abolished.
- The maximum amount which an individual can take as tax-free cash will be frozen at £268,275 — 25% of the current standard lifetime allowance of £1,073,100. Individuals with a right to a higher tax-free cash through scheme specific tax-free cash or in connection with a lifetime allowance protection will still continue be able to keep their higher amount.
What don’t we know yet?
We don’t have full details on the changes to come in from 6 April 2024. For example, from 6 April 2024, it’s not clear how the tax-free cash amount of £268,275 will work from those that have already taken some tax-free cash and how this will be tracked. Also, how the calculation for scheme specific tax-free cash will change.
The lifetime allowance impacts on several other lump sums. The individual must have lifetime allowance available for the following lump sums to be paid:
- serious ill-health lump sum
- uncrystallised funds pension lump sum, and
- winding up lump sum
It’s not clear as to how these lump sums will operate going forward from 6 April 2024.
Further details on the changes since 6 April 2023
What are the changes to the tapered annual allowance?
Since 6 April 2023:
- The annual allowance is reduced for individuals who have ‘adjusted income’ over £260,000 a year.
- The annual allowance reduces by £1 for every £2 over £260,000.
- The maximum reduction is £50,000. Anyone with an adjusted income of £360,000 or more has an annual allowance of £10,000.
- The reduction does not apply to individuals who have ‘threshold income’ of no more than £200,000.
Our tapering of annual allowance for high incomes article provides more details on how the tapered annual allowance works including how to work out adjusted and threshold income.
What are the changes to the lifetime allowance this tax year?
In tax year 2023/24, although no lifetime allowance charge will arise, providers/scheme administrators will need to continue to do lifetime allowance checks and to issue benefit crystallisation event statements.
The following benefits were subject to a 55% lifetime allowance tax charge on the excess above the lifetime allowance before 6 April 2023 but for tax year 2023/24 the excess will instead be subject to income tax at the individual’s marginal rate:
- lifetime allowance excess lump sum
- serious ill-health lump sum
- defined benefits lump sum death benefit
- uncrystallised funds lump sum death benefit
In practice, this means if the excess over the lifetime allowance is paid as a lump sum, income tax at the individual’s marginal rate of tax is deducted from the excess and the balance paid to them. Emergency tax on a month 1 basis will apply unless the provider has a P45 in tax year 2023/24 for the individual.
If pension benefits are to be taken as income, for example as a drawdown pension, there will be no lifetime allowance charge and the income will be taxed at the individual’s marginal rate when the income is taken.
On death, calculating the lifetime allowance used by the deceased is the responsibility of the legal personal representatives. Based on the lifetime allowance information provided by the legal personal representatives, HMRC will now raise marginal rate income tax charge (instead of a lifetime allowance charge of 55%) on any portion of the defined benefits lump sum death benefit or uncrystallised funds lump sum death benefit over the lifetime allowance for any payment in tax year 2023/24.
Transferring to a Qualifying Recognised Overseas Pension Scheme is a benefit crystallisation event (BCE 8). There will be no lifetime allowance charge (25% in this situation) and no UK income tax requirements on these benefits, at the time of transfer, if the individual exceeds the lifetime allowance. When they come to take their pension benefits, they will likely be taxed in the individual’s country of residence.
For clarity, when an individual reaches age 75 with uncrystallised funds and/or funds in drawdown in tax year 2023/24, there will no longer be a lifetime allowance tax charge – this could only have been 25% in these situations before 6 April 2023/24. The provider/scheme administrator will still need to do the lifetime allowance test and to issue benefit crystallisation statements. When the individual takes their benefits as a scheme pension, lifetime annuity and/or as drawdown they will be taxed at their marginal rate of income tax.
What are the changes to enhanced and fixed protection?
From 6 April 2023, an individual who had a valid certificate/reference number for enhanced protection or fixed protection 2012,2014 or 2016 before 15 March 2023, can have a ‘protection cessation event’ and not lose their higher tax-free cash. Protection cessation events include:
- contributions made to a money purchase scheme or pensions savings built up in a defined benefit scheme,
- transfers in non-permitted circumstances, or
- setting up a new arrangement apart from to receive a permitted transfer.
HMRC guidance covers protection cessation event in more detail at HMRC - Pensions Tax Manual: PTM093400 - Protection from the lifetime allowance charge: fixed protection, fixed protection 2014 and fixed protection 2016: losing the protection for fixed protection and HMRC - Pensions Tax Manual - PTM092420: Protection from the lifetime allowance charge: protecting pre April 2006 pension rights: enhanced protection: cessation for enhanced protection.
Any protection cessation event that occurred before 6 April 2023 but after the date of the protection commencement will have lost an individual their enhanced or fixed protection. For enhanced protection, the protection will have commenced on 6 April 2006; for fixed protection 2012 on 6 April 2012, for fixed protection 2014 on 6 April 2014 and for fixed protection 2016 on 6 April 2016.
Individuals who have enhanced protection with lump sum protection registered on their certificate will still be entitled to higher tax-free cash. The value of their maximum lump sum will be based on the same percentage of their benefits value at crystallisation as it was on 5 April 2006. However, the percentage is applied to the lower of:
- their total benefits value on 5 April 2023, or
- their total benefit value at crystallisation
This means any contributions made on or after 6 April 2023 will not lose them their protection (if enhanced protection applied for before 15 March 2023) but will not be included when calculating their tax-free cash.
Those who have a valid enhanced protection without registered tax-free cash or fixed protection 2012,2014 or 2016 that applied before 15 March 2023, any contributions the individual makes from 6 April 2023 can be included for the purposes of calculating their tax-free cash.
It is still possible to apply for fixed and/or individual protection 2016. They are also limited circumstances where late applications for other protections (enhanced, primary, fixed protection 2012 & 2014 or individual protection 2014) can be made. See HMRC Pensions Tax Manual - PTM098000: Protection from the lifetime allowance charge: late submission of notifications for protection from the lifetime allowance charge for further details on late applications. Individuals who successfully apply for protection on or after 15 March 2023, will be entitled to a higher tax-free cash but will still be subject to the rules for protection cessation events. This means if they have a protection cessation event for example, a pension contribution is made, on or after the protection commencement date, they will lose their lifetime allowance protection.
Hamza holds valid enhanced protection, applied for before 15 March 2023, with tax-free cash protection of 50% registered on his certificate. His pension fund was £1,850,000, on 5 April 2023 and, when he comes to take his benefits in May 2024, his pension fund is £2,000,000.
This means his tax-free cash is capped at £925,000 (50% of £1,850,000).
Under the new rules there is no additional tax-free cash on the benefits he accrued after 6 April 2023, assuming the value of their benefits increase after 5 April 2023.
If when, Hamza came to take his pension benefits in May 2024, his fund value has decreased to £1,600,000, he will be entitled to tax-free cash of 50% of this decreased amount, £800,000.
As the value on 5 April 2023 is higher than the value at the time he takes his benefit, the protected percentage is applied to the fund at crystallisation.
Lisa holds valid enhanced protection, applied for on 30 January 2009, with no registered lump sum protection on her certificate.
As she has no tax-free cash protection her protection will be limited to the lower of £375,000 and 25% of the value of her pension fund at the time of the benefit crystallisation event. Any contributions she has made from 6 April 2023 will be included in her tax-free cash.
Lucas makes a successful application for fixed protection 2016 after 15 March 2023.
His tax-free cash will the lower of £312,500 (25% of £1.25 million) or 25% of the value of his pension pot at the time of the benefit crystallisation event.
However, as Lucas applied after 15 March 2023, he must make sure he doesn’t have a protection cessation event, from 6 April 2016, or else he would lose his higher tax-free cash.
What changes are there to standalone lump sums?
Standalone lump sums are where on 5 April 2006 an individual had the right to have all of their pension benefits under a scheme paid as tax-free cash (if they have scheme specific tax-free cash) or all their pension benefits paid out as tax-free cash (if in connection with registered tax-free cash in connection with primary protection or registered tax-free cash in connection with enhanced protection). Normally, tax-free must be paid in connection with a relevant pension (scheme pension, lifetime annuity or drawdown) but a standalone lump sum allows an individual to take benefits without a pension, subject to certain conditions.
Since 6 April 2023, the amount able to be paid as a standalone lump sum will be limited to the value as of 5 April 2023 that could be paid as standalone lump sum. Therefore it appears that any amount over this can’t be included as part of the standalone lump sum and therefore would have to paid as a relevant pension (an annuity or drawdown) or if it meets the conditions, as a trivial lump sum. We are waiting on clarification from HMRC that this is the case.
The information provided is based on our current understanding of the relevant legislation and regulations and may be subject to alteration as a result of changes in legislation or practice. Also it may not reflect the options available under a specific product which may not be as wide as legislations and regulations allow.
All references to taxation are based on our understanding of current taxation law and practice and may be affected by future changes in legislation and the individual circumstances of the investor.