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Abolition of Lifetime Allowance
In our last update we provided an overview of the new pension tax rules coming into effect from 6 April 2024. We also highlighted how the taxation of pension death benefits would work based on the latest draft legislation and policy paper.
To illustrate these changes, below is a case study outlining how the new rules work in practice - Note that this is based on our understanding of the draft legislation as it currently stands, which is still potentially subject to change.
Caroline earns £150,000 a year. She is separated from her husband, but not divorced. She has 2 daughters, Rosie (35) and Whitney (32).
2018/19 tax year
By 1 January 2018, Caroline’s built up a pension pot equalling the then lifetime allowance of £1m. At this point Caroline crystallised benefits worth 100% of the lifetime allowance and took her maximum tax-free cash of £250,000. The residual pension fund was placed in nil income drawdown.
Although a tax-free cash payment does not trigger the money purchase annual allowance, Caroline largely stopped making pension contributions at this time.
2023/24 tax year
On 6 April 2023, the lifetime allowance charge was removed, and the annual allowance increased to £60,000. This led Caroline to begin making large pension contributions again, using both her higher annual allowance and £120,000 of carry forward available from the previous 3 tax years.
Position from 6 April 2024
On 6 April 2024, the lifetime allowance is fully abolished, and the ‘Lump Sum Allowance’ and ‘Lump Sum and Death Benefit Allowance’ introduced. Since Caroline had previously crystallised 100% of the lifetime allowance, her ‘Lump Sum Allowance’ and ‘Lump Sum and Death Benefit Allowance’ is deemed to be £0 (nil).
Benefitting from a ‘transitional tax-free amount certificate’
Caroline provides evidence to her pension scheme that she previously only took £250,000 of tax-free cash and applies for a ‘transitional tax-free amount certificate’. This means that:
Caroline subsequently takes a further £18,275 in tax free cash, which reduces her ‘Lump Sum Allowance’ to £0 (nil) and her ‘Lump Sum and Death Benefit Allowance’ to £804,825.
Position on death
After a short illness, Caroline sadly dies. At this point, her pension pot is worth £1.5m, of which £1,000,000 consists of rights crystallised before 6 April 2024. She also has a pension death in service benefit worth £600,000 (4 x her £150,000 salary). Her total pension death benefits are therefore £2.1m.
Caroline’s death in service benefit is paid as a lump sum to her daughters (Rosie and Whitney). This uses up £600,000 of Caroline’s remaining ‘Lump Sum and Death Benefit Allowance’, leaving £204,825 remaining.
Out of date nomination
Many years ago, Caroline made a pension death benefit nomination and Will in favour of her husband. Following their separation, Caroline amended her Will, but did not update her pension nomination to benefit her daughters.
The beneficiaries of Caroline’s pension are chosen via a discretionary process. It is clear that the nomination is out of date, so Rosie and Whitney are selected to receive the pension. However, as Caroline’s estranged husband is classed as both a dependant and a nominee, a scheme administrator nomination cannot be made and Rosie and Whitney can only be offered a lump sum.
This means that:
If the nomination was updated
If Caroline had known to update her nomination in favour of her daughters, Rosie and Whitney would have had the option to use the pension for beneficiary’s drawdown or a beneficiary’s annuity.
This would have meant that Rosie and Whitney could leave the £1.5m pension fund in a tax efficient pension vehicle, accessing gradually as and when needed. More importantly, due to the removal of BCE5C and BCE5D, it would have meant that the whole £1.5m pension fund could be paid tax free.
Although some details may change between now and 6 April 2024, having up to date death benefit nominations forms in place seems to be as important as ever.
Ideally, nominations should be comprehensive, ensuring all potential beneficiaries are named and specifying the order in which each beneficiary should be considered.
Please note this is for general information only and is based on LV=’s understanding of the relevant legislation and regulations and may be subject to change.
The tax treatment of benefits depends on individual circumstances, and may be subject to change in the future.
The use of this document is at your own risk, and the content should not be used for the provision of professional advice.
LV= accept no liability for any damages, losses or causes of action of any nature arising from your use of this document.