There has (not surprisingly) been some confusion about what has happened to the pensions lifetime allowance from 6 April 2023, following the surprise Spring Budget announcement about its abolition. In the following Q&As, we consider the immediate implications of the changes.
Pensions lifetime allowance and annual allowance changes – considerations for employers
The lifetime allowance is the maximum amount of pension savings an individual may have in total in all of their registered pension schemes at the point(s) of crystallisation (i.e. when some or all benefits are put into payment) before a 55% tax charge applies to the excess (or 25% if the excess is taken as a pension or drawdown, in addition to income tax). For defined contribution schemes, the value of the pension pot is taken into account; for defined benefit schemes, there is a formula to calculate the value of the accrued pension.
The level of the lifetime allowance has varied over time, from £1.5 million when first introduced, to £1.8 million at its highest point, and finally £1,073,100 after three reductions. Various protections to alleviate the impact, all subject to different conditions, have been made available for individuals to claim when the lifetime allowance was first introduced and when it was reduced.
A key point to note is that only the lifetime allowance tax charge has been abolished from 6 April 2023. The lifetime allowance itself and the various protections against the tax charge still exist, at least for the 2023/24 tax year. This is for technical reasons concerning maximum tax-free lump sums and the different taxation of death benefits above and below the level of the individual's available lifetime allowance. The government's intention is that the lifetime allowance legislation will be fully repealed with effect from 6 April 2024.
Is it right that nobody now needs to worry about paying a tax charge for exceeding the lifetime allowance?
No one will pay a lifetime allowance tax charge when benefits are 'crystallised' (i.e. wholly or partially put into payment) on or after 6 April 2023. Unless, perhaps, there is a change in government (see below).
We currently exclude people with lifetime allowance protections from automatic enrolment. Should we now be enrolling them?
There remains an automatic enrolment exception where the employer has reasonable grounds to believe that the worker has a lifetime allowance protection. This was brought in because new pension accrual could cause some types of lifetime allowance protection to be lost and could then result in lifetime allowance tax charges.
Notwithstanding the abolition of the lifetime allowance tax charge, it is still possible for employers to apply this exception because the lifetime allowance and lifetime allowance protections still, for the time being, remain in place.
Whether the exception will remain in place for the longer term will need to be kept under review. This is because pre-15 March 2023 (Budget day) protections are no longer lost where the individual has new pension accrual and there are no longer any lifetime allowance tax charges. So the policy reason for allowing the exception has fallen away. For the time being, however, the option to exclude such individuals from automatic enrolment continues to apply.
Employers might, however, consider whether they wish to continue to apply the exception, now that there is no risk of enrolment resulting in employees incurring a lifetime allowance tax charge. They should note, however, that some employees with protections may still prefer to receive cash instead of pension contributions. This is because of ongoing limits on the amount of tax-free cash that can be taken from registered pension schemes, which remain linked to protection limits. This means that employees who have already accrued benefits up to the relevant protection limits will not be able to take any part of any additional benefits accrued as a tax-free cash lump sum. Individuals automatically enrolled can, of course, still opt out at any time.
Can individuals with lifetime allowance protections now choose to opt in?
Workers who have been excepted from automatic enrolment or who have opted out of membership continue to have the right to opt in (and excepted new employees must still be told about that right at the start of their employment). Many employees may now wish to join the scheme because they will not lose their protection by doing so – but (as noted above) they may not be entitled to tax-free cash from scheme benefits that result from new contributions. Personal circumstances and preferences will differ, and employers should be careful not to give anything approaching advice in this area.
What happens if Labour wins the next general election and reinstates the lifetime allowance?
The Labour Party has promised to reverse the abolition of the lifetime allowance if it comes to power after the next general election (which must be held by 28 January 2025). It has not, however, said anything about past or future protections. Those people who were excepted from, or opted out of, pension scheme membership in order to retain a protection cannot be certain what the effect, under a Labour government, would be if they now opt in on the basis of the 2023/24 tax legislation. There are human rights law restraints on legislating with retrospective effect that would need to be considered before a future government could introduce legislation that penalises earlier behaviour, but the legal analysis here is not easy.
Can people still apply for protections and so fall within the exception?
Applications are still open for fixed protection 2016 and individual protection 2016. These give individuals protections based on the level of the lifetime allowance before it was reduced from £1.25 million to £1 million in 2016, but fixed protection 2016 requires that there be no further pension accrual. Some people may choose to apply for protection, notwithstanding the abolition of the lifetime allowance tax charge, because it can confer an entitlement to a tax-free pension commencement lump sum larger than the standard 25%.
Where the employer has reasonable grounds to believe that an individual has protection, they can be excluded from automatic enrolment (but they have the right to opt in, which they must be told about). Fixed protection 2016 applied for after 14 March 2023 is lost where there is new pension accrual.
Do changes to the annual allowance and/or lifetime allowance impact cash in lieu of pension arrangements?
The Chancellor also announced relaxations of the annual allowance, tapered annual allowance and money purchase annual allowance from 6 April 2023. The key changes are:
- The annual allowance has increased from £40,000 to £60,000.
- The minimum tapered annual allowance that can apply to a high earner has increased from £4,000 to £10,000, and the 'adjusted income' threshold has been increased from £240,000 to £260,000.
- The money purchase annual allowance has also increased from £4,000 to £10,000.
Some employment contracts and/or pension scheme rules limit pension contributions to the standard annual allowance or money purchase annual allowance or tapered annual allowance. Other arrangements may provide options for employees to receive cash instead of pension, either linked to the annual allowance limits above or for employees who might be affected by the lifetime allowance.
The terms of these arrangements will need to be reviewed to see if they still operate as intended, taking account of the changes to the annual allowance limits and the removal of the lifetime allowance charge.
Adjustments may be needed to reflect the new limits. Employers may also want to consider whether they wish to continue such arrangements taking account of the tax changes. Different considerations may apply to cash options which are offered to accommodate annual allowance issues (where tax constraints still apply, albeit at higher levels) compared to those offered to accommodate lifetime allowance concerns.
Will we need to consider this again in 2024?
Unfortunately, it does appear so. We do not yet know what the law applicable in the 2023/24 tax year and beyond will look like.
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