Actions to take on reform of the Lifetime Allowance

Key action points

• Benefits review: consider whether any benefits are limited by the current lifetime allowance or related protections. If so, take advice on the impact of the changes and any options. Note this can apply to scheme rules (for both closed and open schemes) and any external arrangements e.g. for top-ups or life cover.
• Benefits review: consider whether current scheme rules are sufficiently flexible to accommodate the new regime or whether updates are required or helpful.
• Communicate: decide whether to update pension scheme members / employees and how.
• Administration / reporting: arrange to update processes and standard communications (such as crystallisation statements at retirement) to reflect the new regime or check that any third-party providers have this in hand.
• Projects: take advice in relation to any current projects such as a scheme merger, M&A activity and preparation for buy-in/out, as to how to accommodate the changes.

Firstly, what happened in April 2023?

The precursor to all of this happened last year at Spring Budget 2023 when the government first announced its intention to abolish the LTA. This gave the industry advance warning to gear itself up for yet another significant pensions taxation change. The Finance (No.2) Act 2023 started the wheels in motion by removing the LTA charge and making some other ancillary changes to facilitate that. Since April 2023, any amounts that exceed a member’s remaining LTA are treated as pension income and taxed accordingly.

Abolition of the LTA with effect from April 2024

A lot has already been written about the LTA abolition and the new regime. Therefore, we will summarise the key changes and rather focus on the actions that need to be taken by different pension scheme parties as a result.

As mentioned above, the abolition of the LTA is effective from 6 April 2024 and so applicable only to events on and after that date. Therefore the old regime remains in place for pre-6 April 2024 events and will therefore continue to be relevant for exercises carried out after 6 April 2024 but which are intended to have retrospective effect pre-6 April 2024, for example, GMP equalisation. Therefore, it is clear to see that this is going to be incredibly complicated to administer in practice with different regimes applying to different time periods. The legislation and guidance are not final yet, adding another layer to the challenge.

Two new lump sum allowances

From 6 April 2024, the taxation of pension income will be through the existing income tax structure for pension income. There will be two new lump sum allowances as follows:-

• Lump sum allowance – this will be a fixed cumulative limit of £268,275 (25% of the current LTA) on the tax-free cash that can be paid to a person as pension commencement lump sums (PCLS) and as the tax-free part of uncrystallised funds pension lump sums (UFPLS).
• Lump sum and death benefit allowance – this will be a fixed cumulative limit of £1,073,100 (the current LTA) on the tax-free elements of lump sums that can be paid in life and death, to or in respect of an individual.

Any funds taken as a PCLS and an UFPLS will also count toward the overall tax-free limit of £1,073,100, or protected amount if applicable. Where an individual has a scheme-specific lump sum protection and they take a PCLS, their lump sum allowance will not be reduced by the total tax-free amount of the PCLS. It will be reduced by 25% of the lump sum and arising pension.

There is no provision for these fixed allowances to be increased in future tax years in line with inflation.

Reconfigured Pension Commencement Excess Lump Sum

A “new” Pension Commencement Excess Lump Sum has also been introduced. This is clearly not a new concept and it will work in similar circumstances to those in which the current Lifetime Allowance Excess Lump Sum could be paid. However, the main change under the current draft is that it has to be paid in connection with a pension and cannot exceed a permitted maximum. Initial views are that this could in fact be significantly less than the current position as the new excess lump sum does not appear to allow full commutation of excess defined benefit pension, or full payment out of excess money purchase benefits. HMRC has recently confirmed that further consideration is being given to how this option will work.

Helpfully, the new legislation will deem any existing provision in a scheme’s rules for a lifetime allowance excess lump sum to have effect so far as possible as a rule relating to pension commencement excess lump sum after 6 April 2024. It is therefore optional to update rules for clarity / readability.

Transitional provisions

There are a variety of transitional provisions that will apply in order to reflect the position of those who have taken benefits before 6 April 2024 so that they have the 6 April 2024 starting positions for their lump sum allowance and lump sum and death benefit allowance established. In a simple case, there are no future allowances where pre-6 April 2024 benefits taken fully used up the Lifetime Allowance.

Otherwise, by default the two lump sum allowances are reduced by 25% of the Lifetime Allowance that has been used up (except for certain serious ill-health and death transitional cases where the lump sum and death benefit allowance is reduced by 100% of the Lifetime Allowance that has been used up).

However, these deductions are replaced if the individual can apply for their own personal “transitional tax-free amount certificate” that sets out what the deductions should be. They will have to provide the scheme with complete evidence of their history of taking lump sums previously in all registered pension schemes. It is not clear how HMRC intends this process to work in practice and how scheme should operate it (for example where an application for this certificate can be refused) and general consensus within the industry is that guidance will be required.

Required actions and by whom

There are a lot of considerations and actions for all parties involved in the running of a pension scheme, and all in a very short space of time before the Bill becomes law. The main actions/issues to consider are as follows:-

Trustees and pension providers

• Will need to assess, with the help of their advisers and administrators, whether there are any scheme benefit designs that no longer work after 6 April 2024 – e.g. LTA caps on pensions for high-earners - and ensure appropriate advice is taken. It is notable that the current draft legislation does not contain any provision for an overriding power to amend rules.
• Consider with the help of their advisers whether current scheme rules are sufficiently flexible to accommodate the new regime or whether updates are required or helpful for clarity. This involves assessing whether the LTA is hardwired into them and, if so, whether there are any permissive provisions that can be relied upon or whether a specific Rule amendment is required.
• Whether a specific member communication regarding these changes should be prepared to minimise member confusion and queries. At the very least, upcoming member retirement packs will need to be updated, particularly in relation to those members retiring after 6 April.
• If using third-party administration services, check that the third parties have the administrative changes needed in hand (see below) and maintain oversight.

Sponsors

• In addition to their interest in the benefit considerations and any employee communication materials in line with the above, consider whether there are any arrangements outside the registered pension scheme where removal of the lifetime allowance might impact the pension or other benefit provided by the arrangement. This may affect top-up pension or alternative cash arrangements, or any top-up life cover (e.g. excepted life cover schemes) where eligibility criteria links to the lifetime allowance.

Trustees and Sponsors – current projects

• Jointly may need to review any ongoing corporate projects and assess the impact these changes might have – e.g. scheme mergers, bulk transfers, buy-outs where any benefit issues such as those that might be created by these LTA changes will need to be considered and disclosed. Would it be better to do under the new regime or seek to complete under the current regime?

Administrators

• Are systems and processes going to be set up in time to administer these new changes and provide required information to members and personal representatives, and also cater for the transitional provisions?
• New Event Report requirements and systems will need amended to reflect the changes in terms of what will, and will not, require to be reported to HMRC post 6 April.
• Expect to receive an upsurge in member contact, particularly around the transitional certificate point mentioned above from members.

Other points of interest

In recognition of the incredible complexity of the changes being made, it is worth noting the Bill includes a wide power to make further related primary legislative changes as needed until 5 April 2026. Therefore, it seems already envisaged by government that there will be further legislation and tinkering with this new regime required as the industry gets to grips with is application and member/benefit issues are identified in practice.

HMRC has recently stated (Newsletter 155 — January 2024 - GOV.UK) it will be issuing guidance every 2 weeks and is already intending to provide further guidance on these areas:

• the process for reporting lump sum death benefits
• lump sum and lump sum and death benefit statements
• the one-off transitional reporting exercise required by paragraph 130 of Finance Bill 2023-24 (note this relates to members who had a pre-6 April 2024 benefit crystallisation event but no actual entitlement to pension yet e.g. deferred members over 75)
• transitional tax-free amount certificates

• the operation of enhancement factors and closure of applications
• pre-commencement pension rights
• enhanced protection and serious ill-health lump sums
• scheme-specific lump sum protection and stand-alone lump sums
• the taxation of lump sum death benefits paid to non-qualifying persons
• reporting requirements in relation to the overseas transfer allowance
• transitional arrangements for the overseas transfer allowance

It has also been confirmed that points highlighted by the industry about event reporting, reporting of lump sum death benefits and scheme-specific lump sum protections will be corrected. HMRC have also just updated the January 2024 newsletter this week (7 February) to confirm that HMRC will not be legislating to limit which pension schemes individuals can apply for a transitional tax-free amount certificate. HMRC expects applications to be made to the scheme from which the first lump sum is paid after 6 April 2024, but it will remain the case that they can apply to any scheme of which they are a member.

Lastly, as has been widely commented on, the political landscape is very uncertain and with an impending General Election, it is worth noting that Labour at least initially suggested last year that if they get into power they will re-introduce the LTA, though there is no detail on the form and as yet no more recent update regarding their plans for it. Nevertheless there is considerable doubt about the longevity of this new regime in the currently proposed form given the real possibility of a change in government in the not too distant future.

Get in touch

If you would like to discuss any of these changes or to go ahead with reviewing your benefits and/or any communications, please contact your usual Burges Salmon contacts or Alice Honeywill.

This article was written by Mairi Carlin and is current as of 6 February 2024.