Pension providers are currently distributing notifications to numerous taxpayers. Informing them that they have utilized a portion of their Lifetime Allowance (LTA). Given the recent abolition of the LTA, the reason for these letters and their potential significance may be puzzling.
What’s Next After the Abolition of the Pension Lifetime Allowance / LTA?
You might already be aware that the Lifetime Allowance (LTA) was previously a cap on the amount of pension savings eligible for tax advantages. Previously, a hefty tax rate of up to 55% was levied on any pension withdrawals exceeding the LTA at the time of withdrawal. However, in 2023, the Chancellor eliminated the LTA tax, with a complete removal of the LTA set for April 2024. Going forward, amounts that would have been subject to the LTA tax will now be taxed as income instead.
Understanding New Pension Allowances Post-LTA Abolition
With the elimination of the Lifetime Allowance (LTA) in April 2024, two new allowances will be introduced. Influencing how pension savings are accessed for the first time: the Lump Sum Limit (LSL) and the Lump Sum Death Benefit Limit (LSDBL). These allowances are derived from the previous LTA amounts, set at £268,275 for the LSL and £1,073,100 for the LSDBL respectively. The LSL represents the total maximum tax-free amount you can withdraw from your pension savings. While the LSDBL is the amount eligible for tax advantages upon your death. After accounting for any tax-free lump sums withdrawn during your lifetime. It’s important to note that if you secured special protection during previous reductions of the LTA, you might be entitled to higher LSL and LSDBL thresholds.
Potential Pitfalls with Early Pension Access
There is a critical caveat for those who accessed their pension funds before April 6, 2024. Any pension savings crystallized before this date will count towards your previous LTA. Effectively reducing your new LSL and LSDBL dollar for dollar. This is the reason behind the recent flurry of communications from pension providers to individuals with existing pension savings.
Case Study Example: Understanding Impact on Personal Allowances
For instance, consider Karen, who is 64 years old. Karen did not opt for special pension protection, and therefore, the standard LTA rates applied to her. At 59, she accessed one of her pension funds, utilizing 70% of her £1,073,100 LTA before April 6, 2024, which amounts to £751,170. As a result, her LSL and LSDBL are now reduced by £187,792 (25% of £751,170), bringing them down to £80,483 and £885,308, respectively.
Tax Implications of Exceeding the Lump Sum Limit (LSL) Post-LTA
Starting April 6, 2024, if you access any part of your pension savings and the total tax-free lump -sumcombined with previous withdrawals. Surpasses the Lump Sum Limit (LSL), you will face income tax charges on the excess amount.
Illustrative Scenario: Facing Extra Tax Charges
Consider Karen from our previous discussion, who retires at the end of 2024 and decides to withdraw her tax-free lump sum from her remaining uncrystallised pension funds, totaling £130,000. She plans to keep most of this amount in her bank accounts for future needs. However, her withdrawal exceeds her LSL by £39,517 (£130,000 – £80,483). With her other income for the fiscal year 2024/25 amounting to £85,000, the excess £39,517 is added to this income, resulting in an additional tax burden of nearly £21,000. Interestingly, if Karen had postponed her lump sum withdrawal to the next tax year, she could have potentially saved up to £16,000 in income tax.
Strategic Tip for Tax Planning – Lifetime Allowance Limits
Given that excess tax-free lump sums are now subject to income tax, it’s advisable to employ traditional tax-saving strategies. For instance, delaying income, as shown in the example with Karen, can be highly beneficial.
New Regulations Replacing the Lifetime Allowance Limits
From April 6, 2024, new pension lump sum limits will take effect, superseding the Pension Lifetime Allowance (LTA). Any LTA usage prior to this date due to early pension fund access will decrease the amount of tax-free cash you can subsequently extract from your pension savings. Pension providers are issuing letters to clarify the implications of past LTA usage on your current pension limits.