Techzone

With the 6 April fast approaching, it’s important to understand what actions your clients may need to take before the Lifetime Allowance (LTA) is completely abolished. Steps taken this tax year can affect how much tax-free cash can be taken or could secure a higher tax-free lump sum on death under the new rules.

But before taking any action now, it’s critical to ensure that it is both necessary and in the best interests of the client. In fact, some clients may get a better outcome by delaying plans until after April.

Tax-free cash

A new allowance will limit how much tax-free cash can be taken. The Lump Sum Allowance (LSA) caps tax free cash at £268,275 for those without protections. Certain individuals may be able to get more tax-free cash by waiting until the new tax year before drawing benefits.

Assessing tax-free cash

For most people, tax free cash is currently limited to 25% of the amount withdrawn, subject to there being enough LTA available for the amount being crystallised. If tax free cash is not taken at the time of the withdrawal, it's lost.

From April, tax-free cash will instead be limited to the individual’s LSA – typically £268,275, although it may be higher for individuals with LTA protections. As there will no longer be a requirement for ‘available LTA’, an opportunity may arise for some to make good on tax-free cash not taken in the past.

When testing against the LSA, the standard calculation will normally deduct 25% of the LTA used up by benefits taken before 6 April 2024, even in situations where no tax-free cash was taken.

Alternatively, the new rules provide that if clients can evidence how much tax-free cash they’ve actually received in the past, they can apply for a ‘transitional tax-free amount’ (TTFA) certificate confirming the aggregate amount to be deducted from the individual’s available LSA. For some clients this may increase the remaining LSA and, therefore, more tax-free cash than under the standard calculation.

Clients who potentially could receive more tax-free cash post-April by obtaining a TTFA certificate include those who:

• took low or no tax-free cash because their scheme had generous guaranteed annuity rates
• were in DB schemes but didn’t commute pension for their full tax-free cash entitlement
• took benefits during the four years when the LTA was lower than £1.0731M (i.e. 2016/17 – 2019/20)
• transferred uncrystallised benefits to a QROPS – LTA will have been used up without any tax-free cash being paid
• took benefits from a scheme including disqualifying pension credits in respect of pension sharing – we need clarification around this one as there was never any entitlement to TFC, however, they did use up LTA
• are over age 75 and have ‘unused funds’ (i.e. where they haven’t taken benefits yet). These funds will have been tested against, and used up, some of their LTA, so if the standard calculation will deduct 25% of the LTA used from their available LSA, a TTFA certificate could help. 

Just because one of the above applies to a particular scheme, it doesn’t necessarily mean that the client will get more using this method – the overall tax-free cash position needs to be compared to what’s available via the standard calculation.

An individual will only be able to take full advantage of the TTFA certificate route if they have sufficient uncrystallised funds to make up for tax-free cash previously ‘lost’, as normally only up to 25% tax free cash can be taken for each future ‘relevant benefit crystallisation event’ (RBCE) until the allowance is used up.

The certificate is required before the first RBCE from 6 April 2024, otherwise the standard calculation will apply. So, for clients intending to take benefits early in the new tax year, it’s crucial to start gathering information to avoid clients losing out or having to delay taking benefits. Obtaining the details of tax-free cash taken many years ago could prove difficult – maybe even impossible for some.

We still await guidance on how tax-free cash previously taken must be evidenced when making an application for a TTFA certificate.

Scheme-specific tax-free lump sums and fixed/individual protection

Due to a simplification of the formula for calculating tax-free cash entitlement under scheme-specific tax-free lump sum (SSTFLS) protection, those with any of the fixed or individual protections will get more if they wait until April. The greatest increases will be for those with 2012 fixed protection.

Also, when a SSTFLS is taken after 5 April 2024, the excess over 25% will be ignored for LSA purposes.

Lump sum death benefits

While the LTA will no longer exist after April, there will still be a cap on the amount of lump sum death benefits which can be paid tax-free on death before age 75 in the shape of the Lump Sum and Death Benefit Allowance (LSDBA). This has been set at £1,073,100 - the same level of the current LTA - for those without protections.

The LSDBA is a combined allowance for both lifetime tax-free lump sums and tax-free death benefits. So, the amount available for lump sum death benefits will be reduced by any tax-free cash amounts the member has taken.

Should clients crystallise benefits before April?

From next tax year, lump sum death benefits from funds crystallised before 6 April 2024 will not be tested against the new LSDBA. This has prompted many to suggest that high net worth clients should crystallise benefits to take these funds outside of the LSDBA calculations – in particular, clients who have used up their LTA and still have uncrystallised funds. Before 2023/24, this would have resulted in an LTA tax charge.

However, for most, this is a bit of a red herring. If a client is in a scheme where drawdown is an option, and death benefit nominations are in place, then paying lump sum death benefits can normally be avoided. Beneficiary’s drawdown gives flexibility over how much is withdrawn (and when) and withdrawals are tax free, without limit, where the member died before age 75. Pension income is not tested against the LSDBA.

However, there are some clients who may benefit from crystallising this tax year:

• where death benefits will be paid to a bypass trust – for example, where there are vulnerable beneficiaries or complicated family situations
• members with overseas beneficiaries – with some providers, a lump sum may be the only option for a non-UK resident beneficiary
• members in schemes with no drawdown option and where a lump sum would be a preferable death benefit to an annuity
• where a large death-in-service benefit could also be payable

So, crystallising for LSDBA purposes is, in practice, of limited benefit. And for those that haven’t used their LTA yet, they could be taking tax-free cash out of the tax-advantaged pension environment when they possibly don’t need it yet, potentially exposing it to inheritance tax.

The right scheme

Only lump sum death benefits will be tested against the LSDBA on death before age 75, not pension. So, a transfer to a scheme with all the death benefit options could be a good idea. The drawdown option gives the maximum flexibility – withdrawals can be made over time or immediately as a lump sum if needed.

Being in the right scheme can effectively make the LSDBA irrelevant for most. And on death after reaching age 75, having all the options available allows beneficiaries to take the death benefits tax efficiently.

Ensure nominations are in place

With the LSDBA coming into force from April, it’s even more important now to make sure clients have nominated who they want to receive the death benefits from their pensions. Completing a nomination (also known as an ‘expression of wish’) helps guide the scheme trustees when deciding who death benefits should be paid to. But it also ensures that all the options under the scheme are available to the nominated beneficiaries – this is particularly important for non-dependants.

For non-dependants, if they haven't been nominated, but the trustees or scheme administrator decides that they should benefit, then sometimes their only option is a lump sum. This is because, if the deceased had nominated another individual (or a trust or charity) or has a dependant, then the trustees or provider can’t allow anyone else to use the funds for pension purposes.

Enhanced protection and the LSDBA

Clients with enhanced protection will have their LSDBA limited to the value of their uncrystallised rights on 5 April 2024. As they’ve been able to recommence pension funding since 6 April 2023 without invalidating their protection, this means there’s still an opportunity to boost their LSDBA before the new tax year.

Summary

There are still issues to be clarified and HMRC continue drip feed guidance on how the new rules will be applied in practice. But there are certain actions that clients can take before April to potentially position themselves for a better outcome, particularly in relation to lump sums paid on death.

Equally, there will be those thinking of taking benefits who may be better off waiting until the new tax year to maximise the amount of tax-free cash available.

It’s therefore as important to identify those clients who should not do anything yet, as much as those who may need to take action before the tax year end.