Overview of pension reforms from 6 April 2024

Introduction

The government announced at Spring Budget 2023 that the lifetime allowance charge would be removed from 6 April 2023 and the lifetime allowance itself would be abolished from 6 April 2024. Finance (No.2) Act 2023 included provisions to abolish the lifetime allowance charge together with other consequential changes. Although the lifetime allowance charge no longer exists, the lifetime allowance remains relevant for the 2023/24 tax year to determine the size of certain lump sums and how lump sums may be taxed. Following a consultation led by HMRC, Finance Act 2024 included provisions to remove the lifetime allowance and to make a number of consequential adjustments to UK pensions tax regime. 

Abolition of the lifetime allowance

As noted above, the lifetime allowance remains relevant for what remains of the 2023/24 tax year to determine the treatment of various lump sums. The main one that pension savers encounter in their lifetime is the 25% tax-free pension commencement lump sum (or “PCLS”), which is normally capped at 25% of the available lifetime allowance. For those who die before reaching age 75, the lifetime allowance also affects how lump sum death benefits from uncrystallised funds will be taxed. These lump sums are generally tax-free to the extent that there is unused lifetime allowance. Prior to 6 April 2023, any excess over the lifetime allowance was taxed at 55%. In the 2023/24 tax year the excess is taxed at the recipient’s marginal income tax rate.

The lifetime allowance will be abolished from 6 April 2024, but two new lifetime limits are being introduced in its place. Rather than considering the total value of savings that an individual has accumulated, these consider the tax-free elements of pension savings only. These limits are:

• The lump sum allowance (LSA) – The aggregate of PCLSs and tax-free elements of uncrystallised funds pension lump sums (UFPLS) received in a pension saver’s lifetime will be capped at £268,275 (25% of £1,073,100, the current standard lifetime allowance limit). 
• The lump sum and death benefit allowance (LSDBA) – The aggregate tax-free elements of lump sums paid in a pension saver’s lifetime and in death will generally be capped at £1,073,100 (some lifetime benefits that are not tested against the LSA are similarly excluded from the LSDBA test). This allowance is only relevant where the pension saver dies before reaching age 75. 

The amounts of LSA and LSDBA available for lump sums taken on or after 6 April 2024 may be reduced under transitional measures if the individual used any of their lifetime allowance (see below).

Where the individual has a lifetime allowance protection that provides for a higher lifetime allowance and/or higher PCLS, the above figures are similarly enhanced. For example, if an individual holds Fixed Protection 2016, giving them a lifetime allowance of £1,250,000, their LSA would be £312,500 (25% of £1,250,000), and their LSDBA would be £1,250,000. 

For Enhanced Protection the position is slightly different. Generally, the LSA will be based on the amount that could have been taken as a PCLS as at 5 April 2023 and the LSDBA is based on the value of uncrystallised rights as at 5 April 2024. 

Applications for Fixed Protection 2016 and Individual Protection 2016 will close from 6 April 2025. Similarly, applications for certain lifetime allowance enhancement factors, including the non-resident enhancement factor, will close from the same date. Those who are eligible but have not yet applied should therefore consider whether this would be beneficial.

Where funds in pension schemes are used to provide the pension saver with taxable income (e.g., drawdown or annuity), this element does not need to be tested against the new limits and is therefore uncapped. The amount used in this way is still relevant for determining how much PCLS is allowed, however. For example, if a pension saver with a standard lifetime allowance of £1,073,100 has an uncrystallised fund worth £1,500,000, they can therefore take £268,275 tax-free as a PCLS provided they use at least £804,825 (i.e., three times the PCLS) to provide pension income. They can use the full £1,231,275 remaining to provide income if they wish. Unlike the regime that applied before 6 April 2023, the excess benefits over £1,073,100 are not subject to a separate tax charge. Pension income received is then taxed at the pension saver’s marginal income tax rate.

If the pension saver reaches age 75, the new regime generally has either a neutral or a beneficial effect in lifetime and on death. For those who die younger, the treatment of lump sum death benefits can be better or worse from 6 April 2024, depending on the circumstances.

Death benefits for those who die before age 75

Since 6 April 2015, death benefits paid in respect of pension savers who die before age 75 have generally been tax-free provided they were paid within two years of the scheme administrator becoming aware of the death (or could first reasonably have been expected to be aware). The main exception to this was where a pension saver died with uncrystallised funds that exceeded their available lifetime allowance. As noted above, the excess is currently taxed at the recipient’s marginal income tax rate if it is paid as a lump sum death benefit (previously 55%). Where uncrystallised funds are used to provide pensions for dependants or nominees, however, the benefits can potentially be taken completely tax-free. The amounts used are tested against the available lifetime allowance, but since 6 April 2023 this does not give rise to a tax charge (there was previously a 25% lifetime allowance charge on the excess). Under the current rules, the beneficiary can therefore then receive tax-free pension income.

From 6 April 2024, lump sum death benefits will be tested against the available LSDBA, with the excess being taxed at the recipient’s marginal income tax rate. Unlike the lifetime allowance test, the new test includes lump sums derived from crystallised funds (e.g., flexi-access drawdown), subject to transitional measures carving out funds crystallised before 6 April 2024. If crystallised or uncrystallised funds are used to provide pensions for dependants or nominees, these are not tested against the LSDBA and will continue to be provide tax-free pension income to the beneficiary.

The table below compares the tax treatment of a selection of death benefits from pensions held by those who die before reaching age 75 (assuming beneficiaries are individuals and that benefits are applied within the two-year period mentioned above):

Transitional measures

Where a pension saver has used any of their lifetime allowance for benefits crystallised before 6 April 2024, their LSA and LSDBA will normally be reduced by default. Both allowances will normally be reduced by 25% of the amount of lifetime allowance treated as being used. This broadly replicates the current position whereby any further PCLS may not exceed 25% of the unused lifetime allowance.

The individual can override the default position by obtaining a transitional tax-free certificate before taking their first benefit after 5 April 2024 that needs to be tested against the new allowances. They need to have complete evidence of the amounts that they have actually received tax-free. If they satisfy the requirements, the LSA and LSDBA will be reduced by the aggregate tax-free amounts. This will normally only be beneficial where the individual received less than 25% of their pension benefits tax-free (e.g., because of the rules of their scheme only permitted a smaller proportion) or where the lifetime allowance was lower at the time of the crystallisation.

There are situations where it can be detrimental to obtain a transitional tax-free certificate. In particular, this can arise where benefits were crystallised prior to a reduction in the individual’s lifetime allowance. The calculations should therefore be considered carefully before an application is made.