The Lifetime Allowance changes and their impact on inheriting a pension

On 6 April 2024, the Lifetime Allowance (LTA) was fully abolished by the UK Government. This represented a significant change in pension legislation, serving to remove the cap on the tax advantages enjoyed on pension assets accrued over an individual’s life. So, what is the impact of removing the LTA on pension savings?

What was the LTA?

The Lifetime Allowance was a limit on the total value an individual could accrue in pension assets before incurring tax penalties. When the LTA was first introduced in 2006, it was set at £1.5 million, rising to £1.8 million in 2010 before falling back down to £1 million in 2016. Since then, it increased only modestly, reaching £1,073,100 in 2020 before being frozen at this level.[1] Before 6^th of April 2024, withdrawing pension savings in excess of the LTA would incur tax charges of:

• 25% if taken as income (with the remainder taxed at the individual’s marginal rate of income tax)
• 55% if taken as a lump sum.

The primary reasons the Government looked to remove the LTA were to encourage economic activity, and to discourage individuals from retiring early for fears of their pension savings breaching this limit (particularly those working in the healthcare sector).[2]

Prior to the removal of the LTA in April 2024, “tests” were carried out against the LTA when an individual received benefits from their pensions. These were known as Benefit Crystallisation Events (BCEs). Effectively, these tests assessed how much of the LTA had been used. They were carried out in the case (for example) a member began taking an income from their pension, took their tax free cash, and on payment of some death benefits. In total, there were 13 different BCEs. By removing the LTA entirely, the Government sought to reduce the complexity in relation to taking benefits, albeit with debatable success.

Impact on pension savings

By removing the LTA, individuals no longer have to worry about punitive tax charges on pension benefits accrued in excess of £1,073,100, which could be hugely beneficial for high-earners and those who have lengthy careers. That being said, the gross annual pension allowance of (currently) £60,000 still applies.[3]

What has replaced the LTA?

The LTA was replaced by three new allowances:

1. The Lump Sum Allowance (LSA), which limits the total amount of tax-free lump sums a person can receive before their marginal rates of tax apply. This has been set at £268,275 (equivalent to 25% of the last lifetime allowance of £1,073,100). This may be higher if an individual has a form of pension protection, such as Fixed Protection or Individual Protection.[4]
2. The Lump Sum and Death Benefit Allowance (LSDBA), which limits the aggregate lump sums that can be paid tax-free during an individual’s lifetime and on death, which is set at £1,073,100 for those individuals who do not have transitional pension protections or enhancements. This allowance includes certain lump sums paid on death before age 75 and serious ill-health lump sums paid before age 75.³
3. The Overseas Transfer Allowance (OTA), which limits the maximum tax-free amount that can be transferred out of the UK. This is set at the same value as the LSDBA, £1,073,100.³

Both the LSA and the LSDBA limit the amount of tax-free lump sum that can be paid.

Scheme administrators now need to check whether the payment of a pension lump sum will exceed the LSA or the LSDBA. These tests are (somewhat confusingly) referred to as relevant Benefit Crystallisation Events (rBCEs).[5]

What’s changed for death benefits?

Prior to the removal of the LTA, the way pension death benefits were treated depended heavily on whether the individual passed away before or after the age of 75[6]:

• If an individual were to die before the age of 75, the remaining funds within a pension could be passed on to beneficiaries tax-free, provided that the total value of the pension fell within the LTA limit. Any pension benefits in excess of the LTA were subject to a lifetime allowance tax charge; 55% on the excess if taken as a lump sum and 25% if taken as income.
• If death occurred after the age of 75, then any withdrawals made by the inheriting beneficiaries were subject to tax at their marginal rates of income tax. There was, however, no lifetime allowance tax charge.

In either case (death pre- or post-75), the pension benefits could be passed on free of inheritance tax, making them extremely efficient tools for Inheritance Tax (IHT) planning.

With the LTA no longer in place, pension savings can now be inherited without fear of incurring a lifetime allowance tax charge. Due consideration still needs to be paid to whether death occurs pre- or post-age 75, and whether the pension assets fall within the lump sum and death benefit allowance (LSDBA):

• If death occurs before age 75, then anything paid as a lump sum and within the LSDBA will be paid tax-free; whilst pension benefits received in excess of LSDBA will be taxed at the beneficiaries’ marginal rates of income tax.
• If death occurs after age 75, then the inherited pension benefits are taxed at the recipients’ marginal rate of income tax, as usual.

It is worth noting that under the new regime, it is only lump sums which are subject to testing and could be taxed. As a result, it is crucial to make sure that beneficiaries have the option of taking their inherited pension benefits as an income (i.e. in the form of drawdown). If they can, there will be no tax to pay, regardless of the amount of pension savings, provided that the funds are paid out to beneficiaries within a standard “two-year window”, which typically starts from the date the pension scheme administrator is informed of the death. If death occurs after the age of 75, the pension assets a beneficiary receives will be subject to income tax as normal. It also remains the case that in most circumstances, pension assets are free of inheritance tax.

Potential challenges

When the previous Conservative Government announced they intended to abolish the lifetime allowance in 2023, with the change due to come into effect in April 2024, the wider financial planning industry highlighted the fact that implementing this change quickly would present a significant challenge.[7] The full ramifications of this decision are still being felt by pension scheme administrators, who are still working in conjunction with HMRC to accurately track historic pension crystallisation events (where scheme members have taken benefits) and the interaction between the taking of historic benefits and the new allowances.

The impact of the 2024 Autumn Budget changes on your pension

Whilst there were concerns that a new Labour government would immediately reinstate the lifetime allowance, these didn’t eventuate.[8] Instead, The Chancellor, Rachel Reeves, announced in the 2024 Autumn Budget that pensions would now be liable to Inheritance Tax and become a part of your estate from April 2027 (we go into further detail about this in our Budget analysis).[9]

To summarise these changes,

• If a person passes away, pensions transferred between married couples or civil partners won’t be impacted due to spousal exemption
• In most circumstances, if they die before age 75, the pension is part of their estate for inheritance tax (IHT) purposes, but beneficiaries won’t pay income tax on it
• In most circumstances, if they die after 75, the pension remains part of their estate for IHT, and beneficiaries will pay income tax at their marginal rate, resulting in double taxation

It’s worth noting these changes won’t come into effect until April 2027 and they are currently going through a consultation period (consequently these changes won’t impact you for several years). However, updates to the proposed changes could still be made before 2027. If you are concerned or have questions, please get in touch with your financial adviser.

What this all means for you

As noted above, the abolition of the LTA is particularly good news for high earners, as well as those who intend to have lengthy careers and can afford to continue to contribute to their pensions. Removing the cap on pension assets has presented better opportunities for inheritance tax planning and intergenerational wealth planning. However, if the proposed changes from the recent 2024 Budget announcement come into effect this will impact these opportunities. As ever, it is important that you seek financial advice.