Pareto: New Pension Tax Framework

The implications of these changes will largely depend on individual circumstances, such as the total value of one’s pension savings, any prior withdrawals from pension schemes and existing lifetime allowance protections, or scheme specific tax free cash.

Delving into the Lump Sum Allowance
The introduction of the Lump Sum Allowance (LSA) aims to cap the tax-free sums that can be withdrawn from pension schemes. Set at £268,275, this allowance may adjust based on factors including previous pension withdrawals or the presence of Lifetime Allowance protections or protected tax free cash allowances. From 6 April 2024 onwards, tax free lump sums taken will be deducted from the individual’s LSA.

The LSA applies to both the Pension Commencement Lump Sum (PCLS) and the tax-exempt portion of any Uncrystallised Funds Pension Lump Sum (UFPLS), with these withdrawals also being assessed against the available Lump Sum and Death Benefit Allowance (LSDBA). Typically, the maximum tax-free lump sum accessible will be determined by the lowest of 25% of the benefits being accessed, the remaining LSA and the LSDBA.

Exploring the Lump Sum and Death Benefit Allowance
The Lump Sum and Death Benefit Allowance (LSDBA) further restricts the tax-free lump sums withdrawable from pensions and those payable to beneficiaries upon the policyholder’s demise pre age 75. This allowance does not apply to benefits already in drawdown before 6 April 2024.

Initially set at £1,073,100, the LSDBA may vary depending on previously taken pension benefits or existing lifetime allowance protections. The LSDBA covers the exact lump sums as the LSA but additionally applies to serious ill-health lump sums disbursed before age 75 and lump sum death benefits if the policyholder passes away before reaching age 75.

Posthumous benefits are only subject to the LSDBA when paid out as tax-free lump sums. Conversely, suppose benefits are allocated to provide a beneficiary with a drawdown pension. In that case, they are exempt from being tested against these allowances, with income typically remaining tax-free if the policyholder dies before age 75, lump sums may be tested, however, lump sums paid out post designation to beneficiary drawdown would not be tested. Despite previous suggestions, these provisions will remain unchanged from 6 April 2024 as per the current legislation, however any excess will be taxed at 45%.

Navigating the new Overseas Transfer Allowance
The introduction of the Overseas Transfer Allowance (OTA) marks a pivotal change in the landscape of overseas pension transfers. From 6 April 2024, individuals looking to move their pensions to a Qualifying Recognised Overseas Pension Scheme (QROPS) will find their transfers assessed against the OTA, a departure from the previous system that utilised the Lifetime Allowance.

The OTA is set to mirror an individual’s Lump Sum and Death Benefit Allowance (LSDBA), with a key distinction: reductions to the OTA will only occur through the actual value transferred to QROPS, not by any tax-free lump sums withdrawn post-6 April 2024. Transfers that exceed the OTA threshold will incur a 25% Overseas Transfer Charge.

Adjustments for previous pension withdrawals
Individuals who began drawing down their pensions before 6 April 2024 will see an adjustment to their available allowances. For those who accessed benefits before 6 April 2006 and have not made any additional withdrawals since then, the calculation of new allowances will hinge on the annual income being drawn or entitled.

By contrast, pensions accessed after 6 April 2006 and evaluated against the Lifetime Allowance will see a reduction in available allowances. Specifically, the Lump Sum Allowance (LSA) and LSDBA will decrease by 25% of the total lifetime allowance utilised, with exceptions made for certain circumstances such as receipt of a serious ill-health lump sum before age 75 or disbursement of lump sum death benefits before 6 April 2024.

Transitional certificates and age considerations
Individuals may benefit from for a transitional tax-free amount certificate in specific scenarios, particularly where the maximum tax-free cash was not taken despite utilising the lifetime allowance. This certificate, likely relevant to those with final salary pensions or annuities without tax-free cash withdrawals, will show the required allowance adjustments based on the lump sums received.

Furthermore, the significance of turning 75 shifts under these new rules. For those who reached age 75 on or after 6 April 2024, pension benefits will be tested against allowances only when taking a tax-free lump sum or making an overseas transfer, a change from the previous necessity of testing against the Lifetime Allowance.

Securing Lifetime Allowance Protections
For those who meet the prerequisites, opportunities still exist to apply for Fixed Protection 2016 and Individual Protection 2016 until 5 April 2025. These protections safeguard individuals’ pensions against potential tax implications by potentially enhancing allowances. This provision underscores the importance of timely action and consultation to ensure eligibility and application within the stipulated deadlines.

Professional financial advice is invaluable for those seeking additional information or clarity on how these changes might affect their pension planning or requiring guidance on applying for protections.