To reduce the tax complexity faced by individuals whose registered pension savings or life insurance benefits reached the Lifetime Allowance (LTA), the United Kingdom has eliminated the LTA and introduced two other allowances with more favorable tax treatment for those who exceed them. The Finance (No.2) Act 2023 removed the Lifetime Allowance charge with effect from 6 April 2023, and the subsequent Finance Act 2024 removed the Lifetime Allowance in its entirety but introduced the Lump Sum and Death Benefit Allowance (LSDBA) and the Lump Sum Allowance (LSA).
The LSDBA is the limit on the combined value of tax-free lump sums that can be paid in respect of an individual before marginal rate taxation arises. This includes any tax-free lump sums used up under the LSA (see following), any benefits paid as a serious ill-health lump sum, and any tax-free lump sum death benefits paid. The LSA is the maximum amount individuals can take from all their pension schemes as tax-free cash.
Key Changes:
Effective 6 April 2023, the 55% tax charge on Registered Pension Schemes and/or lump sum life assurance benefits that exceed the Lifetime Allowance (GBP 1,073,100) was removed. Any excess above the Lifetime Allowance became subject to income tax at the recipient’s marginal rate.
Effective 6 April 2024, the Lifetime Allowance was removed in its entirety, and the LSDBA and LSA were introduced. Any benefit above the LSDBA under a Registered Scheme set up under a discretionary trust will now be subject to income tax at the recipient’s marginal rate. The LSDBA is currently set at the previous Lifetime Allowance (LTA) figure of GBP 1,073,100.
Individuals with valid Fixed or Enhanced Protection will be able to accrue new pension benefits, join new arrangements, or transfer without losing their protection – provided this protection was applied for before 15 March 2023, and a certificate or reference number was subsequently issued from 6 April 2023. Those who were granted such protection on or after 15 March 2023 are subject to restrictions to accrual and transfer as per the previous Lifetime Allowance rules.
Lump sum life assurance benefits provided via an excepted trust are not subject to the same legislative requirements and are not subject to either the new LSDBA or income tax charge.
Lockton Comment: It should be noted that these changes tend to impact UK employees with well-funded defined contribution pension pots and/or who have participated in a defined benefit pension for a long time or who have high levels of life assurance in group life schemes.
Calculations
HMRC guidance has noted that when calculating the proportion of the death benefit in excess of the LSDBA, most tax-free benefits paid from a Registered Pension Scheme during the individual’s lifetime will be deducted from this allowance. These include but are not limited to the following:
Lump Sum Allowance
Serious Ill Health Lump Sum
Pension Commencement Lump Sums
How these payments will impact the LSDBA depends on whether the payments were made before or after 6 April 2023. For employees with Enhanced and Fixed Protection rights, the LSDBA assessment will be based on their agreed protection levels. Those calculations are a personal tax rather than an employer matter.
Reporting on Registered Group Life Arrangements
HMRC has noted that the new arrangement has not changed reporting requirements for Scheme Administrators. HMRC has also noted that the Scheme Administrator shall give a statement confirming where a relevant crystallization event has impacted the employee’s LSDBA. At the point of a death claim, for the confirmation of any tax due (as with the current system), the Legal Personal Representatives (normally the next of kin or a lawyer appointed by them) will need to advise HMRC if they believe a charge may be due, and HMRC will review and confirm. This may mean that HMRC approaches a beneficiary or beneficiaries at the end of the tax year with a marginal rate tax charge.
We suggest the Trustees inform those receiving any benefit that the Legal Personal Representative should check to see if any tax is due on the benefit paid.
Group Life Insurers
Insurers are updating the Deed and Rules of Registered Pension Scheme Master Trust arrangements to align with the updated legislation. They are also amending the wording of policies that refer to the Lifetime Allowance to reference the LSDBA instead.
Pension Arrangements
There are further issues to consider regarding pensions. HMRC issued a newsletter on 4 April 2024 advising that there are cases where pension members may wish to delay taking benefits until it can amend legislation around the abolition of the LTA. The cases relate primarily to individuals with existing LTA protections or who plan to transfer their pension savings to a qualifying recognized overseas pension scheme (QROPS). The specific cases are those that involve:
Pension scheme-specific tax-free cash protection
Transfers with enhanced protection
Enhanced protection and primary protection cases with protected lump sum rights of more than GBP 375,000
The payment of a lump sum death benefit from funds that crystallized prior to 6 April 2024
Transfers from drawdown to a QROPS
Transfers to a QROPS, which involves pre-April 2006 benefits
Transitional Tax-free Amount Certificates (TTFACs)
TTFACs have been introduced for individuals who have taken pension benefits prior to 6 April 2024, where the LSA and LSDBA will be reduced by a transitional amount. In most cases, this will reduce the LSA and LSBDA by 25% of any LTA used up before 6 April 2024. However, some individuals may be entitled to a higher amount if, for example, they have taken less than their 25% tax-free cash. These individuals can apply for a TTFAC, which gives them a lump sum allowance based on the actual value of lump sums they received.
TTFAC applications are made via the pension provider/administrator and must include evidence of the previous lump sum amounts paid. The pension provider/administrator then has three months to either supply the certificate to the individual or state why a certificate has been refused. Pension providers are currently establishing their processes for dealing with TTFAC applications. It is important to note that if an individual applies for a certificate and puts them in a detrimental position, they cannot withdraw their certificate.
Lockton Comment: The government intends to simplify the rules and remove/realign some of the more onerous protection rules. Higher-earning professionals have argued that the LTA encouraged early retirement purely for tax reasons, with doctors and surgeons noting the undue stress that places on the NHS. However, there is still potential for a significant tax charge associated with benefits exceeding the LSDBA of GBP 1,073,100.
When reviewing group life trust arrangements or pension schemes, employers should be mindful of:
Rules relating to employees with pension protection joining new pension schemes and registered group life assurance arrangements have been relaxed if they had these protections in place prior to 15 March 2023. This relaxation should benefit the vast majority. However, if protection was granted on or after 15 March 2023, the old rules apply, and they will invalidate their protection if they join a new pension scheme or registered group life assurance arrangement.
There is still a significant tax charge applicable to lump sum death benefits in excess of the new LSDBA of GBP 1,073,100. It is lower than the 55% under the previous Lifetime Allowance rules but could still be up to 45%, depending on the individual’s marginal tax rates.
Effective 6 April 2024, new factors will now impact the amount of LSDBA a death claim will be assessed against for tax calculation purposes.
Although some of the initial benefits of setting up an excepted trust have been rolled back (i.e., enhanced/fixed protection impact), they are not subject to the income tax charge on benefits over the LSDBA and would still be useful should a new employee join with very recent pension protection benefit on or after 15 March 2023. Therefore, they are still relevant and should be considered by employers.
Based on current legislation, Lockton would not recommend closing an existing excepted trust at this time. Should an existing excepted trust be approaching a 10-year anniversary since execution, it should be discussed with legal/tax advisers to ensure that it continues to meet business and people objectives.
Actions for employers to consider:
Find out what these changes mean for your group life assurance and pension arrangements by obtaining guidance from your Lockton People Solutions team.
Consideration should now be given under the new rules on how an employee manages their pension or if they have received a lump sum following a serious illness which may impact any potential income tax charge on death benefits payable under an insured registered arrangement. Having the death benefit written under an excepted trust may assist in mitigating a potential tax issue for the employee’s beneficiaries.
Consider issuing a communication to employees who have previously submitted pension protection certificates impacted by the Lifetime Allowance highlighting the changes to the LTA and suggesting they obtain professional financial advice, including whether they should apply for a TTFAC ahead of the first time they plan to crystallize any benefits after 6 April 2024. They should consider HMRC guidance regarding cases where members may wish to consider delayingdelay taking their benefits until legislation is amended.
Advise employees considering taking pension benefits with a substantial pension fund or planning to transfer their savings to a QROPS to seek professional financial advice.
Review any high earners’ policies to ensure these remain appropriate.
If any employees were excluded from your last triennial re-enrolment cycle to avoid losing LTA protection, consider if this is still the correct approach and contact them to see if they wish to rejoin the pension.
Consider communicating with impacted members to highlight the fixed and individual protection 2016 deadline of 5 April 2025.
Check with your pension provider for updated member communications or modeling tools referencing the LTA.
The Future
Lockton will continue to monitor the guidance provided by HMRC, noting that prior to winning the general election on 4 July 2024, Labour publicly stated that they would reverse these changes. However, it has been reported that they will be reversing this decision, allegedly because the cap would add uncertainty for savers and be complex to reintroduce.
Please contact your Lockton Consultant if you want to discuss these changes or the potential impact on group life arrangements or pensions.
Additional information can be obtained from HMRC using this link (opens a new window).