Untangling the lifetime allowance changes - what they mean for your workforce
In the 2023 Budget, then-chancellor Jeremy Hunt announced he would abolish the pensions lifetime allowance (LTA) – the amount that employees can save into a pension - tax-efficiently - over their lifetime.
Before its abolition, the LTA was £1,073,100.
For most employees, the LTA comfortably exceeded the amount of money they would ever save into a pension.
High-earners, and even some more moderate earners, however, risked facing punitive tax bills or losing the option of saving into a pension.
But the legislation to support the LTA abolition is still a work in progress, with grey areas that could yet cause problems for some employees approaching retirement. As yet, there’s no timetable to fix the problems.
The LTA was formally abolished on 6 April 2024, and new limits on tax-free cash were introduced: the lump sum allowance (LSA) and lump sum and death benefit Allowance (LSDBA).
At the same time, the chancellor also introduced changes to the annual allowance (AA) - the amount that someone can save into a pension tax-efficiently in a single year, and the money purchase annual allowance (MPAA) - the amount someone can save into a pension after they have started to make withdrawals from their funds.
At a glance: why does this affect reward and benefits?
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The short-term problems with the LTA legislation will only affect a handful of employees. But, they are likely to be more senior employees, and they are more likely to be thinking about retirement right now.
- In the longer term, the abolition of the LTA, introduction of the LSA and LSDBA, and the changes to the AA and MPAA could alter the way that employees save into their pensions and the decisions they take when accessing their savings.
- Abolishing the LTA should also re-open workplace pensions for high earners who were previously affected by the limits on tax-efficiency.
The new tax-free allowances: The LSA and the LSDBA
Lump sum allowance
Under the previous rules, employees over age 55 could take 25% of their pension savings as tax-free cash, no matter what the size of their pension pot.
There is now a cap of £268,275 on the tax-free cash that someone can take from their pension, known as the lump sum allowance (LSA).
The LSA currently equates to 25% of the old LTA figure of £1,073,100. But, unlike previously, the LSA is now a fixed sum rather than a percentage.
Lump sum and death benefit allowance
The limit on all tax-free lump sums from pensions is £1,073,100. This includes lump sums taken:
- When someone is alive, counted towards their LSA.
- Any serious ill-health lump sum before age 75 (usually taken if life expectancy is less than a year).
- If someone dies before age 75 and beneficiaries receive money from their pension within two years after their death (i.e. death benefits).
Typically an employee or their beneficiaries won’t be affected if the total LSDBA is below £1,073,100.
But if a death benefit is paid from a pension that was accessed before 6 April 2024 for someone who is under the age of 75, the whole amount is tax-free, because it falls under the previous LTA rules.
Industry insight: Emma Hadley, head of pensions, Howden Employee Benefits & Wellbeing
At the moment the LSA and LSDBA changes won’t affect many people, as few will have a pension pot that is over £1,073,100, and therefore their LSA limit will still equate to 25% tax-free.
But there is nothing in the current legislation to allow for increases in the LSA or LSDBA figures over time.
If the LSA limit remains the same and as more people accumulate pension pots greater than £1,073,100, this will represent a reduction – effectively reducing tax-free cash by attrition. The same consideration applies to the LSDBA.
That doesn’t mean people shouldn’t carry on accumulating the best possible outcome for their retirement.
But it does mean that if there is no increase mechanism in future, more people will have reduced tax-free cash, so employees might want to be sure they are not relying on 25% of their pension to pay off a mortgage, for example.
To-do list for employers:
- It’s very important that employees are made aware of the new allowances.
- Over time, if they're affected by a reduction in tax-free cash, they’ll need to think about how they might mitigate that reduction.
Emma Hadley
Increases in annual allowance and money purchase annual allowance
Annual allowance
At the same time as the LTA announcement, the chancellor also increased the annual allowance (AA), from £40,000 per year, to £60,000.
This will give higher earners more opportunity to save into pensions tax-efficiently. Any unused AA from three previous tax years can also be brought forward, so if employees get a one-off windfall, from a share scheme or a large bonus for example, they could also save this tax-efficiently.
Money purchase annual allowance
Once employees have started to access their pension savings, they can only save the amount of the money purchase annual allowance (MPAA) into their pension each year tax-efficiently.
The MPAA was increased from £4,000 per year to £10,000 per year. The higher figure could help employees who have accessed their pensions during a period of ill-health, for example, to rebuild their savings.
Industry insight: Eleanor Daplyn, partner, Sackers
Many employers will have offered affected individuals alternatives to all or some of the pension benefit they could have taken, to help manage exposure to the LTA and AA charges.
The AA implications will now be less, and, as things stand, many of the LTA issues will fall away entirely.
To-do list for reward and benefits
- There are two considerations to be aware of – the first is that the scope for providing tax-efficient life cover for those with large benefits has now really opened back up. This is a benefit that’s typically highly valued by employees so worth focusing on early.
- Whenever contemplating future pension provision, employers should keep their automatic enrolment duties firmly in mind. This includes taking especial care to prevent plans floundering on auto-enrolment anti-avoidance rocks, for example because they are regarded as “inducing” employees to opt out.
Eleanor Daplyn
Industry insight: Steve Watson, director of policy and research, NatWest Cushon
From an employer perspective it’s about helping employees understand the difference between the old and new approach.
Employees can now build a pension with no limits, but lump sum tax consequences still remain.
To-do list for employers
- Perhaps the most important point for employers is a potential rethink to their auto-enrolment approaches. There’s no reason to exclude people who have fixed protection, as long as they received it before 15 March 2023 (see ‘Enhanced protection and the LTA section below), so should they now auto-enrol these employees?
- As for employers offering pension redirect to those who breached or had the potential to breach the LTA, they now need to consider if it’s still appropriate. Or they could help educate members so they can make their own informed decisions.
Steve Watson
Enhanced protection and the LTA
Enhanced protection was first introduced in 2006. Its aim was to help people protect their savings from tax if they had pension pots in excess of the newly introduced LTA, or who expected their pension savings to go above the LTA over their working lifetime.
There have been several other points over the intervening years when people could apply for protection, in line with reductions in the LTA.
These meant someone could protect their savings from tax up to the value of the previous LTA, rather than the new, reduced allowance.
The most recent was 2016 – and even though the LTA has now been abolished, it’s still possible to apply for protection related to 2016 until April 2025.
If someone has enhanced protection, it could also affect their tax-free cash allowance, including being entitled to more tax-free cash than the new LSA and LSDBA limits.
One of the grey areas under the new regime affects employees who withdrew tax-free cash from their pension before 6 April 2024 (when the LTA was abolished and the LSA/LSDBA were introduced).
They may need a transitional tax-free amount certificate (TTFAC) to make sure they receive the correct allowance.
The legislation also raises several potential issues when members move between pension arrangements in a group.
That could mean scheme mergers and other company projects involving changes to pension arrangements may be on hold.
Industry insight: Phil Duly, principal and head of DC research and technical, and James Jones-Tinsley, self-invested pensions technical specialist, Barnett Waddingham
While the enhanced protection and LTA change issues are only likely to apply in a few niche scenarios, they will be significant for anyone affected by them.
Employees with certain types of enhanced protection that maintained their LTA and tax-free cash at a higher level could be impacted, as well as people who are looking to transfer their pensions, either within the UK or even offshore.
To-do list for reward and benefits:
- Make sure that employees don’t discard enhanced protection certificates – if anything, those are more valuable than ever now because they protect higher LSAs and LDBAs.
- Employers might also want to check cash in lieu arrangements for those that had LTA protection and start to think about whether employees could go back into the pension scheme.
- For those that are affected, employers can help with education and access to advice. Employers always worry about tripping over into providing advice, which they can’t do, but they could consider providing access to an independent financial adviser or equivalent to assist employees with the new rules.
- For workplace pension schemes, check if the LTA was written into the scheme rules. There is a statutory override which runs until April 2029, but schemes will still need to make rule changes as appropriate.
Phil Duly
