The removal of the Lifetime Allowance (LTA) in April 2024 marks a major shift in how pensions are taxed and structured in the UK. This change eliminates the cap on the amount you can save in your pension without incurring significant tax penalties, but it also brings with it new challenges and considerations for retirement and estate planning. Let’s take a closer look at what the changes mean for pension savings and inheritance, and how you can navigate them effectively.
What Was the Lifetime Allowance (LTA)?
The LTA was a limit on the total amount of pension assets an individual could accumulate without facing tax penalties. Introduced in 2006 at £1.5 million, it was gradually reduced over the years, reaching £1,073,100 in 2020. Pension savings above this amount were subject to heavy tax charges: 25% on income withdrawals and 55% on lump sum withdrawals. The aim of the LTA was to limit the amount of tax relief high earners could claim on their pension savings.
With its abolition in April 2024, individuals can now contribute more to their pensions without worrying about exceeding the LTA limit and incurring these punitive taxes. However, there are still annual contribution limits and new allowances to consider.
The Impact on Pension Savings
For many high earners and long-term savers, the removal of the LTA is a welcome change. Without the LTA limit, there’s now more flexibility to grow your pension pot without the fear of a large tax bill. However, there is still a £60,000 annual allowance for pension contributions, which remains unchanged.
What Replaces the LTA?
In place of the LTA, three new allowances have been introduced:
- Lump Sum Allowance (LSA): This limits the total tax-free lump sum an individual can receive before income tax applies. The LSA is set at £268,275, which is 25% of the old LTA.
- Lump Sum and Death Benefit Allowance (LSDBA): This allows for tax-free lump sums during a person’s lifetime and after their death, with a cap of £1,073,100. This includes certain lump sums paid on death before age 75 and serious illness lump sums.
- Overseas Transfer Allowance (OTA): This limits the maximum tax-free amount that can be transferred out of the UK, set at £1,073,100, aligning with the LSDBA.
These new allowances replace the LTA and will be used to assess pension lump sums and death benefits. Administrators now must check whether a pension payment exceeds these new allowances, using what are called relevant Benefit Crystallisation Events (rBCEs).
What’s Changed for Pension Death Benefits?
Before the LTA’s removal, pension death benefits were taxed differently depending on whether the individual died before or after age 75:
- Before 75: Pension funds could be passed to beneficiaries tax-free if the total pension value was within the LTA. Any excess was taxed heavily.
- After 75: Beneficiaries would pay income tax on the inherited pension benefits.
Now that the LTA is gone, pensions can be inherited without the risk of incurring the LTA tax charges. However, the rules for how pensions are taxed after death still depend on whether the death occurs before or after age 75:
- Before Age 75: Lump sums within the LSDBA are paid tax-free; any excess is taxed at the beneficiary’s income tax rate.
- After Age 75: Inherited pensions are taxed at the recipient’s income tax rate, but there is still no inheritance tax.
It’s important to note that, in most cases, pension assets are still free of inheritance tax, which makes pensions an attractive option for passing on wealth.
Potential Challenges
Although the removal of the LTA simplifies things for many savers, it also creates challenges. One major issue is the complexity in tracking past pension crystallisation events, especially for scheme administrators who are still adjusting to the new rules. These administrators are working with HMRC to ensure proper management of the new allowances, which could lead to confusion and delays in processing pensions.
The 2024 Autumn Budget and Future Changes
In the 2024 Autumn Budget, Chancellor Rachel Reeves confirmed that pensions will become part of an individual’s estate for inheritance tax purposes starting in 2027. This means that while pension funds will remain free of income tax for beneficiaries, they will be included in the estate for inheritance tax calculation. If a person dies after age 75, their pension will be subject to income tax, and this could result in double taxation for the beneficiaries.
While these changes won’t take effect until 2027, they could have a significant impact on your inheritance planning. It’s important to plan accordingly, particularly for those with large pension pots.
What Does This All Mean for You?
The removal of the LTA provides more opportunities for long-term savers to grow their pension pots without worrying about exceeding a tax threshold. However, it’s crucial to be mindful of the new limits and how they impact the taxation of pensions on death. High earners and those planning for retirement over the long term will benefit most from this change, especially if they are looking to maximise their retirement savings.
But with proposed changes to inheritance tax on pensions in 2027, it’s important to stay informed and adjust your planning strategies accordingly. Working with a financial adviser can help you navigate these changes and make the most of the new opportunities for pension savings and estate planning.
