UK Government Abolishes Lifetime Allowance for Pensions, Adds Surprising Twist
The UK government has announced its decision to abolish the lifetime allowance for pensions, a move that aims to remove financial barriers for high-skilled individuals such as NHS clinicians. This measure, which was initially introduced in 2006, sets a maximum limit on benefits under a pension scheme before penal tax charges are imposed on any excess.
As of April 6, 2023, the lifetime allowance charge will no longer apply, and by April 6, 2024, the lifetime allowance will be completely abolished. The hope is that this change will not only incentivize skilled professionals to remain in the workforce but also contribute to a stronger labor market and boost economic activity.
However, it’s important to note that this doesn’t mean there will be no limit on the tax treatment of pension benefits going forward. A new cumulative threshold called the lump sum and death benefit allowance will be introduced, which will be set at the same level as the current lifetime allowance. Lump sums and lump sum death benefits will be tested against this new threshold and will be subject to taxation through the existing income tax structure.
For lump sum death benefits, the tax treatment will still depend on the member’s age at the time of death. If the member dies before age 75, the benefits will remain tax-free (assuming they are paid out within two years and below the new threshold). However, if the member dies after age 75, the benefits will continue to be taxed as pension income.
The maximum limit for tax-free cash will remain at £268,275, except when certain protections apply. Any tax-free cash taken will also count towards the overall tax-free limit of £1,073,100 or protected amount. Any lump sums paid above this limit will be taxed at the individual’s or beneficiaries’ marginal tax rate.
The new lump sum and death benefit allowance represents a significant change from the previous lifetime allowance since it includes more than just lump sum benefits. Previously, entitlement to a pension, reaching age 75, and transferring to an overseas pension scheme were events that could use up an individual’s lifetime allowance. The reform brings some simplification to the pensions framework.
However, a surprising twist in this policy paper is the government’s intention to no longer exclude inherited pensions, passed on from individuals who die before age 75, from marginal rate income tax. This change could potentially remove one of the major benefits of a defined contribution pension scheme. The ability to retain accumulated savings in a tax-advantaged wrapper, where investments can continue to grow free from income and capital gain taxes, has been a popular option for many beneficiaries. This change would mean that the favorable tax treatment of passing on pension wealth in this way would be relatively short-lived, having only been introduced in 2015 under the ‘freedom and choice’ reforms.
With these changes set to come into force in eight months, individuals now have an opportunity to assess whether these modifications align with their own circumstances. The uncertainty surrounding these reforms makes it challenging for individuals to make a definitive decision.
