From April 6, 2024, the Lifetime Allowance (LTA) for pensions will be a thing of the past. This marks a significant shift in how retirement savings are taxed in the UK.
Here’s a straightforward breakdown of what this change means for you and how to make the most of the new pension landscape.
What’s Changing?
The LTA, which previously capped the amount you could build up in pension benefits without incurring extra taxes, is being removed.
Instead, new rules are coming into play, focusing on limiting tax-free lump sum payments while removing limits on funds used to provide a taxable pension income.
In essence, while you won’t have a cap on your total pension savings, there will be restrictions on how much tax-free cash you can take out.
The LTA is Dead, Long Live the LSA and LSDBA 🫤
We can forget about the LTA. However, we now have 2 more acronyms to deal with.
Lump Sum Allowance (LSA)
This cap limits the tax-free lump sums that can be taken during a person’s lifetime.
It has been set at £268,275, i.e. 25% of the old LTA.
It applies to tax-free cash and certain lump sums from pensions that haven’t yet been turned into a regular retirement income.
Lump Sum and Death Benefits Allowance (LSDBA)
This broader allowance limits tax-free lump sums payable both in lifetime and on death.
It has been set at £1,073,100 (i.e. the same level as the old LTA).
This allowance is important for estate planning, especially concerning inheritance.
Examples of the New Rules in Action
Example 1: If Susan has a pension pot of £800,000, she can take up to £200,000 as a tax-free lump sum.
This would use 74.55% of her LSA.
Example 2: If Mike has a pension pot of £1.5 million (without any form of protection) and takes £250,000 as a tax-free cash lump sum, then moves £300,000 into drawdown, he leaves £950,000 untouched.
If he passes away before 75, the maximum tax-free sum his beneficiaries can receive is calculated after subtracting the already taken £250,000 from the LSDBA. I.e. £823,100.
Lump sum payments beyond this limit will be taxed according to the beneficiary’s income tax rate.
However, if it is paid as income, it won’t be taxed as Mike was below age 75 at death.
Example 3: If Mike passes away after age 75 however, payments made as income would be taxed according to the beneficiary’s income tax rate.
Planning for Retirement and Beyond
The removal of the LTA and introduction of these new allowances necessitate a fresh approach to retirement planning:
💡 Reassess your retirement strategy in light of these changes: Tools and calculators provided by pension providers can help understand the new allowances’ impact on your pension pot.
💡 Review your pension plans: Ensure your nominations allow for benefits to be paid as income/beneficiary’s drawdown. This is particularly important if you’re nearing or above the LSDBA limits.
💡 Existing LTA protections: If you’ve taken steps to protect your pension from the LTA tax charges, these protections might give you higher allowances under the new rules. It’s important to review these protections to maximize your tax-free benefits.
💡 Consider transitional certificates: If you didn’t take your full tax-free lump sum due to unfavorable conditions previously, applying for a transitional tax-free cash certificate might enable you to maximize your tax-free withdrawals.
What to do if you are a pension beneficiary?
Understanding the implications of receiving pension benefits as a lump sum versus as an income is more crucial than ever, particularly in light of the different tax treatments.
Further reading: What Do I Do With an Inherited Pension?
The Bottom Line – What This Means for Retirement Planning
✔️ No More LTA Concerns: The abolition of the LTA removes the worry about accruing pension benefits beyond a certain limit. This can lead to more flexible retirement planning.
✔️ New Limits to Understand: With the introduction of the LSA and LSDBA, individuals will need to understand these new caps and how they impact the tax-free portions of their pensions.
✔️ Estate Planning Implications: The LSDBA, in particular, has significant implications for how pension benefits are passed on to beneficiaries, especially in terms of tax treatment.
The abolition of the Lifetime Allowance marks a significant shift in UK retirement planning, one that offers both challenges and opportunities.
If you’re wondering what these changes mean for you and how you can best prepare for a tax-efficient retirement, I’m here to assist.
By understanding your unique situation, we can tailor a strategy that aligns with your goals. Contact me to find out more.
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