Techzone

The new pensions rules announced in the Budget certainly caught everyone by surprise and left advisers with a number of questions as to how their clients will be affected in the coming years.

Not all of these questions can be answered at this stage as the legislation for 2024/25 and beyond will be in next year's Finance Bill. And, of course, there will be another general election to negotiate too. But we do know how the rules will impact advice in 2023/24.

The annual allowance related changes are fairly self-explanatory. But we've been getting a number of questions around the lifetime allowance (LTA) and tax free cash changes. Here are some of the more common questions we've been taking.

1. How does the 'new' tax free cash limit apply in 2023/24?

The Budget announced a headline limit on tax free cash of £268,275 - 25% of the current LTA.

In practice, this is only the case for those who haven't yet crystallised any benefits, are subject the standard LTA, and whose tax free cash rights from all schemes are 25%.

In 2023/24, when benefits are crystallised, LTA testing will continue to operate as before and the tax free cash available will generally be the lower of 25% of the benefits or 25% of that individual's remaining LTA.

Tax free cash rights could be more or less than the headline figure – for example, those with LTA protections could get up to 25% of their protected LTA, those with scheme-specific tax free cash protection could get more than 25% (if there's sufficient remaining LTA), and those with disqualifying pension credits (credits received from funds crystallised after A-Day) following divorce could get less.

2. How will tax free cash entitlement be worked out from April 2024?

The intention is that the LTA will be abolished altogether from 6 April 2024. However, there will still need to be a way of tracking how much tax free cash has been taken and how much (if any) is left.

It's unlikely that this will be as simple as totalling up any amounts of tax free cash already taken and subtracting this from the headline figure of £268,275. This would be unfair on those with LTA protections, or those who previously took some tax free cash when the LTA was at a higher level. Also, as mentioned above, some clients will be entitled to either more or less than 25% tax free cash.

We'll have to wait and see what mechanism will be introduced to achieve this.

3. Will tax free cash entitlement be fixed or increasing?

The Budget document stated that tax free cash will be "retained at its current level of £268,275 and will be frozen thereafter", which implies there will be no automatic indexation.

If this is the case, this could reduce the value of tax free cash in real terms over time. Once again we will need to see the legislation for 2024/25 and beyond to understand if there is potential for future increases in the maximum amount of tax free cash entitlement.

4. What was the change to tax free cash for those with enhanced protection?

For those who don't have registered tax free cash rights there is no change.

The change only applies to those who have registered tax free cash rights under enhanced protection – i.e. this was only available to those who had tax free cash rights in excess of £375,000 at A-Day. Their enhanced protection certificate confirms the tax free cash entitlement as a percentage of their uncrystallised funds – this percentage can be paid as tax free cash each time benefits are crystallised.

However, from 6 April 2023, this protection will be capped at the tax free cash value on 5 April 2023.

5. Should clients who have crystallised benefits up to their LTA crystallise any benefits in excess of the LTA this tax year?

There is a good reason for these individuals to crystallise the rest of their benefits. It's all about the taxation of their death benefits should they die before age 75.

Uncrystallised benefits in excess of the LTA, if paid as a lump sum death benefit, will be subject to the beneficiary's marginal rate, whereas lump sum death benefits over the LTA from crystallised benefits would be tax free. So, crystallising these funds while there is no LTA charge in place does have merits. There's no requirement to draw any of the benefits – if the plan allows drawdown, they can simply be designated for drawdown.

This issue with uncrystallised funds and death benefits over the LTA only applies to lump sums – if the beneficiary instead chooses beneficiary's drawdown or an annuity, the income would be tax free. But remember, to ensure the pension options are available to non-dependant beneficiaries, it's important to get the right nominations in place.

6. Where clients have benefits over the LTA, should they crystallise everything now as there's no LTA tax charge in 2023/24?

Where significant benefits within the LTA are still uncrystallised, there perhaps isn't such a strong argument as there is in crystallising the excess benefits (see Q5), unless the tax free cash is needed.

Crystallising benefits when the cash or income is not needed will simply move funds out of the tax advantaged pension wrapper. It also potentially exposes it to IHT.

Some advisers have expressed concerns about a Labour government reintroducing the LTA if elected. But planners can only advise on what they know. Anything else is speculation. Planning for what could happen may end up being the wrong advice if the predicted changes don't happen, or are applied in a different way to what has gone before.

7. How do those who have already used 100% of their LTA crystallise the excess without taking any benefits?

Assuming the scheme has the option of income drawdown, this is simply a case of contacting the provider and asking for the excess to be designated into drawdown.

If the scheme doesn't have the drawdown option, the member would need to transfer to a scheme which does.

8. What change was made to the taxation of lump sums over the LTA?

The change applies to certain retirement and death benefit lump sums paid in excess of the individual's available LTA – ones which would previously have been subject to a 55% LTA tax charge. These are:

• LTA excess lump sums
• Serious ill-health lump sums (i.e. where uncrystallised funds are fully commuted for individuals with a life expectancy of less than 12 months)
• Lump sum death benefits from uncrystallised funds
• DB lump sum death benefits (typically 'death-in-service' lump sums)

These lump sums will now be subject to income tax at the recipient's marginal rate.

9. Is there any point in registering for FP2016 or IP2016 now?

With the removal of the LTA tax charge and the intention to remove the LTA completely from 2024, many have assumed that the LTA protections are no longer relevant. However, that's not the case! There are still good reasons to register for these protections:

• Tax free cash - they can provide a higher entitlement to tax free cash. For example, someone with fixed protection 2016 potentially could take tax free cash of £312,500 (25% of £1.25M) rather than the standard £268,275 – an extra £44,225 tax free.
• Lump sums - certain retirement and death benefit lump sums (as mentioned above) in excess of the LTA would previously have been subject to a 55% LTA tax charge. These will now be subject to income tax at the recipient's marginal rate. So, again, having a higher LTA means less will be subject to tax.
• Benefits crystallised since 5 April 2016 - as these protections are backdated to 6 April 2016, any benefits crystallised since then would have been tested against the standard LTA. By registering for protection now, the percentage of LTA used can be recalculated, meaning that more of the LTA may still be available. And more tax free cash too.

Of course, FP2016 is only available if there haven't been any DC pension contributions or DB benefit accrual after 5 April 2016.

10. Can enhanced or fixed protection be lost if pension funding restarts after 5 April 2023?

Those who had registered their protection by 15 March 2023 – and didn't do anything to invalidate it before 6 April 2023 – can recommence pension funding without fear of losing their protection. This includes the ability to carry forward unused annual allowance.

However, for clients who register after 15 March 2023, the old rules will still apply and they would lose their protection if pension funding recommenced.

11. Does it still make sense to keep funding if it won't produce any more tax free cash?

Where employer contributions are on offer then, absolutely – better a taxed benefit than no benefit. The possible exception is those that have registered for fixed protection 2016 after 15 March 2023 – they would lose their protection.

As for personal contributions, it still makes sense so long as they won't pay tax at a higher rate on the way out than the relief they get on the way in. In addition, once in the pension, the funds have the potential to grow tax free and are generally outside of the estate for IHT purposes.

12. Has scheme-specific tax free cash protection been capped?

No, scheme-specific tax free cash will continue to be calculated as before.

However, stand-alone lump sum protection has. Historically, the stand-alone rules allowed individuals who had tax free cash rights at 5 April 2006 of 100% of the value of their occupational pension schemes for a particular employment to take all of those benefits as tax free cash.

But, from 6 April 2023, the amount that can be paid tax free under these provisions will be limited to the value on 5 April 2023.