Policy paper

Abolition of the Lifetime Allowance

Updated 18 July 2023

Who is likely to be affected

Individuals who receive lump sum payments or death benefits from registered pension schemes, and those who have or intend to apply for Lifetime Allowance (LTA) or lump sum protections.

Scheme administrators of registered pension schemes who will need to modify their processes to accommodate changes to the taxation of lump sums and lump sum death benefits, including for those with LTA protections or lump sum protections and changes to Benefit Crystallisation Events (BCEs).

General description of the measure

At Spring Budget 2023 the government announced that it would abolish the LTA. Finance (No.2) Act began this work by removing the LTA charge and delivering some further changes. This measure completes the work to abolish the LTA.

This measure delivers the changes required to abolish the LTA and clarify the tax treatment of pension savings. It clarifies how lump sums and lump sum death benefits will be taxed in its absence, the position of individuals with LTA protections, lump sum protections or LTA enhancement factors and the function of BCEs.

Policy objective

This measure supports the government’s efforts to encourage inactive individuals to return to work, in particular those aged 50 and above, by delivering on the commitment to abolish the LTA following the removal of the LTA charge.

Background to the measure

The LTA was introduced in 2006 as a mechanism for limiting tax-favoured pension savings in registered pension schemes. It was the maximum amount of tax-relievable pension savings an individual can benefit from over the course of their lifetime. Individuals could contribute to their pension over this limit, but they were subject to a tax charge on any amounts above the allowance. The original limit was £1.5 million. The LTA was later raised to £1.8 million and then reduced incrementally to its most recent level of £1,073,100.

Since the onset of the pandemic there has been an increase in economic inactivity in the UK — an increase that is larger than for other advanced economies. The government believes that a strong labour market is critical to economic growth in the UK. Within this, encouraging labour market participation, and in turn growing the UK labour market, is a key mechanism to support the economy to produce more and increase GDP.

In Finance (No. 2) Act 2023 legislation was introduced to prevent individuals from becoming liable to the LTA charge from 6th April 2023 onwards. This was intended to incentivise those currently considering retirement to remain in employment, and to encourage those who have already left the workforce to return. Further changes are required to support the removal of the LTA charge, to deliver on the removal of the lifetime limit for total tax-relievable pension savings, and to ensure that pension tax continues to function effectively in the absence of the LTA charge and limit.

Detailed proposal

Operative date

The legislative changes made in this measure will have effect on and after 6 April 2024.

Current law

The removal of the LTA charge and much of the wider framework for the LTA impacts multiple different areas of pension tax. All references are to Finance Act 2004 unless specified otherwise.

Lump sums and lump sum death benefits

Section 166 sets the rules for lump sums. Schedule 29 requires the individual to have available LTA for the benefit to be paid. This condition applies to:

• pension commencement lump sums (PCLS)
• serious ill health lump sums (SIHLS)
• uncrystallised funds pension lump sums (UFPLS)
• trivial commutation lump sums (TCLS)
• winding up lump sums (WULS)

Schedule 32 sets out that the payment of PCLS, SIHLS and UFPLS are BCEs.

Section 166 and Schedule 29 set out that an individual whose crystallised funds exceed their available LTA can be paid a Lifetime Allowance Excess Lump Sum (LTAELS)

Schedule 29 sets the maximum PCLS at the lesser of 25% of the capital value of the individual’s pension benefits coming into payment and 25% of their available LTA. It also sets the maximum tax-free amount of an UFPLS at 25% of an individual’s available LTA. For individuals subject to the standard LTA of £1,073,100, this means the maximum for both is £268,275.

Section 168 sets the rules for lump sum death benefits and Schedule 29 provides further detail:

• Uncrystallised Funds Lump Sum Death Benefit (UFLSDB)
• Defined Benefit Lump Sum Death Benefit (DBLSDB)
• Pension Protection Lump Sum Death Benefit (PPLSDB)
• Annuity Protection Lump Sum Death Benefit (APLSDB)
• Flexi-access Drawdown Lump Sum Death Benefit (FADLSDB)
• Drawdown Pension Fund Lump Sum Death Benefit (DPFLSDB)
• Trivial Commutation Lump Sum Death Benefit (TCLSDB)

Part 9 Income Tax (Earnings and Pensions) Act 2003 (ITEPA) taxes the TCLSDB as pension income. The tax treatment of the remaining lump sum death benefits depends on the member’s age at death and whether the benefit is paid to a qualifying or non-qualifying persons. Chapter 15A ITEPA sets out that:

• when the member dies aged under 75 and the payment is made to qualifying persons it is generally not taxable, unless paid two years or more after the member dies, in which case it becomes taxable at the beneficiaries’ marginal rate
• when the member dies aged 75 or over and the payment is made to qualifying persons it is taxed as pension income
• when the member dies aged under 75 and the payment is made to non-qualifying persons it is generally not taxable, unless it is made two years or more after the member dies, in which case it becomes subject to a 45% tax charge called the special lump sum death benefit charge (SLSDBC) (Chapter 4 ITEPA)
• where the member dies aged 75 or over and the benefit is paid to non-qualifying persons it is always subject to the SLSDBC (Chapter 4 ITEPA)
• the only exceptions are APLSDBs and PPLSDBs which are never subject to the SLSDBC

Schedule 32 sets out that the payment of an UFLSDB or DBLSDB is a BCE where the member dies under age 75. For all lump sums/ lump sum death benefits which are BCEs, any excess over the individual’s available LTA was subject to an LTA charge. Finance (No. 2) Act 2023 provided that no new LTA charge would arise from 6 April 2023 and, where the LTA charge previously applied, made SIHLS, LTAELS, DBLSDB and UFLSDB taxable at the individual’s or beneficiaries’ marginal rate.

LTA Protections, Lump Sum Protections, and LTA Enhancement Factors

When the LTA was introduced, and each time it has been reduced, protections were offered to individuals who had already built significant pension savings with the expectation of a higher level of LTA. Most protections also give individuals an entitlement to a higher level of tax-free lump sum (PCLS) and higher tax-free amounts of lump sums tested against the LTA. Each protection has its own set of rules and application window:

• Primary protections (PP) — Schedule 36
• Enhanced protections (EP) — Schedule 36
• Fixed protections (FP) — Schedule 18 Finance Act (FA) 11
• Fixed protection 2014 (FP14) — Schedule 22 FA13
• Individual protection 2014 (IP14) — Schedule 6 FA14
• Fixed protection 2016 (FP16) — Schedule 4 FA16
• Individual Protection 2016 (IP16) — Schedule 4 FA16

The rules for EP, FP, FP14, and FP16 included restrictions on benefit accrual (protection cessation events). Finance (No. 2) Act 2023 provided that, where an individual had validly applied for these protections before 15 March 2023, these events will no longer apply.

When the LTA was introduced, there were also separate lump sum protections offered to those who had rights before 5 April 2006 to a higher level of tax-free lump sum. These are the protection of lump sum rights exceeding £375,000 for individuals with PP or EP, and scheme-specific lump sum protection (Schedule 36).

Articles 25 to 25D, SI 2006/572 provide that either of these lump sum protections might enable an individual to take the entirety of their pension benefits tax-free as a Stand-Alone Lump Sum (SALS). Finance (No. 2) Act 2023 capped the maximum tax-free amount that can be taken as a SALS at the value that could have been paid on 5 April 2023, with the remainder taxed at the individual’s marginal rate.

For individuals with PP or EP but no separate lump sum protection, Schedule 29 provides that where their entitlement to a PCLS arose after 5 April 2014 and the SLTA is less than £1.5 million, £1.5 million is to be used in place of the SLTA for the purposes of calculating their available portion for a PCLS.

For individuals who became entitled to pension credits prior to 5 April 2006, Schedule 36 provides for an LTA enhancement factor at all BCEs. This enhancement is based on the SLTA for the tax year 2006 to 2007 of £1.5 million.

Sections 220-226 provide further circumstances under which individuals may be entitled to an enhanced LTA based on the SLTA at the time of the BCE: pension credits from previously crystallised rights, non-residency, and transfer from a recognised overseas pension scheme.

Schedule 36 provides that individuals with a Protected Pension Age (PPA) of less than 50 but who take benefits before Normal Minimum Pension Age (NMPA) have their LTA reduced.

Benefit Crystallisation Events and charges

Sections 214-219 sets out:

• when a charge to income tax (the LTA charge) arises where a BCE occurs in relation to an individual and the amount of this charge
• when each BCE occurs and the amount that is crystallised by each of those events
• the value and availability of an individual’s LTA that applies at the time of a BCE

Proposed revisions

Lump sums and lump sum death benefits

The taxation of pension income will be through the existing income tax structure for pension income. Authorised lump sums and lump sum death benefits will be tested against a new threshold, set at the same level as the present Lifetime Allowance, £1,073,100. Individuals will not pay tax where lump sums do not take them above this level. Any lump sums paid above this level will be taxed at the individuals’ or beneficiaries’ marginal rate.

Although treated as pension income, these benefits will be exempt for the purposes of the tapered Annual Allowance (AA) and the Government Actuary Department (GAD) rate. This limit is to apply per person and not per scheme. It will be a personal limit against which all lump sums and lump sum death benefits, from all registered pension schemes, will be tested. It will not take into consideration the payment of regular pension income.

The maximum tax-free limit for a PCLS or UFPLS will remain at £268,275, except where protections apply. Any funds taken as a PCLS or UFPLS will also count toward the overall tax-free limit of £1,073,100, or protected amount.

The requirement to have available LTA to take any lump sum payment will be removed.

The LTAELS will be removed in the absence of the LTA.

For the payment of uncrystallised and crystallised lump sum death benefits, in the event a member dies under age 75 and the benefit is paid to:

• qualifying persons, it will be counted towards the deceased member’s lump sum tax free limit, and the excess will be taxed at each beneficiaries’ marginal rate
• non-qualifying, it will be counted towards the deceased member’s lump sum tax free limit and the excess will face a basic rate income tax charge under Part 9 ITEPA. If the payment is made outside of the two-year period and the SLSDBC currently applies in this scenario, then the individual would continue to be subject to this charge

Protections and lump sum protections

Give eligible individuals until 5 April 2025 to apply for FP 2016 and IP 2016.

Ensure that individuals with valid lump sum protections retain their right to a higher level of tax-free lump sum.

Ensure that individuals with valid LTA protection retain their right to a higher level of tax-free lump sum, and to higher tax-free parts of lump sums and lump sum death benefits.

Ensure that individuals with an LTA enhancement, based on pre-commencement rights to pension credits, retain their rights to a higher level of tax-free lump sum, and to higher tax-free parts of lump sums and lump sum death benefits.

Remove all other LTA Enhancement Factors for any BCE occurring from 6 April 2024.

For individuals with valid EP, limit the tax-free part of any lump sum or lump sum death benefit to the total value that could have been paid on 5 April 2024. Marginal rate taxation will be applied on any excess.

For individuals with a PPA below 50, where they take pension benefits before NMPA, provide that their single tax-free limit for lump sums and lump sum death benefits be reduced by 2.5% for every year between their first BCE and the date they reach NMPA.

Benefit Crystallisation Events and charges

Ensure that tax year 2022 to 2023 will be the last tax year that the standard LTA is set at £1,073,100. The removal of the LTA means that the standard LTA will not apply as a lifetime limit for all pension savings for the tax year 2023-2024 onwards.

Remove BCE 1, BCE 2, BCE 3 and BCE 4 with effect from 6 April 2024.

Remove BCE 5, BCE 5A and BCE 5B with effect from 6 April 2024.

Remove BCE 5C and BCE 5D with effect from 6 April 2024.

Individuals will still be able to receive the benefits which are currently tested against the LTA at BCEs 5C and 5D, but the values will no longer be excluded from marginal rate income tax under ITEPA, with effect from 6 April 2024.

Summary of impacts

Exchequer impact (£ million)

2023 to 2024	2024 to 2025	2025 to 2026	2026 to 2027	2027 to 2028	2028 to 2029
—	—	—	—	—	—

The final costing will be subject to scrutiny by the Office for Budget Responsibility (OBR) and will be set out at the next fiscal event.

Economic impact

The macroeconomic impacts on the labour market which will occur as a result of the removal of the LTA charge were assessed as part of Spring Budget 2023 Pension Tax Limits TIIN.  In their March 2023 Economic and Fiscal Outlook (EFO), the OBR estimated that changes to the lifetime allowance and the annual allowance on pension contributions will increase employment by around 15,000 in 2027 to 2028.

Impact on individuals, households and families

This measure will have a positive impact on individuals saving into a registered pension scheme who are entitled to receive lump sum benefits, or whose beneficiaries are entitled to receive lump sum death benefits. This is because regular pension income will no longer be taken into account for the purposes of the maximum lump sum threshold of £1,073,100, or an individual’s protected level. This increases members’ tax-free lump sum entitlements.

Furthermore, this tax-free threshold will no longer restrict the overall value that can be taken as a relevant lump sum, and lump sum benefits which exceed this monetary cap will be taxed an individual’s or beneficiaries’ marginal rate.

The measure is not expected to have an impact on family formation, stability, or breakdown.

The measure introduces no new or different responsibilities for individuals. It is overall expected to improve individuals’ experience of dealing with HMRC as the changes simplify the pension tax system and reduce their tax admin obligations.

Equalities impacts

It is not anticipated that there will be any impact on groups sharing protected characteristics beyond males who are close to or at retirement age.

Impact on business including civil society organisations

This measure is expected to have a negligible impact on businesses administering registered pension schemes.

One-off costs could include familiarisation with the changes to payment conditions and taxation of lump sum and lump sum death benefits, to the conditions of LTA protections, to the removal of certain BCEs. One-off costs might also include updating software in-line with these changes.

Continuing costs are broadly expected to remain the same as there will be no testing of a member’s funds against the LTA but instead schemes will be testing against the tax-free lump sum and lump sum death benefit limit. This will require a similar amount of information to be recorded and a similar level of reporting to HMRC, if not a reduction in the provision of data and information.

This measure is expected overall to improve business’ experience of dealing with HMRC as there will be a reduction of tax admin obligations in the long-term.

This measure is not expected to impact civil society organisations.

Operational impact (£ million) (HMRC or other)

To support the delivery of this measure, HMRC will need to update its guidance and the processes for schemes reporting taxable elements of lump sums and lump sum death benefits. These process changes will require HMRC to make changes to its IT systems and digital services. The overall cost of these changes is still being determined but currently estimated to be in the region of £15m. Additionally, there will be a small cost associated with additional Full Time Equivalent required to support customers in implementing this measure. This cost is estimated to be in the region of £1.5m across the scorecard period.

Other impacts

Other impacts have been considered and none have been identified.

Monitoring and evaluation

This measure will be kept under review through communication with pension scheme administrators.

Further advice

If you have any questions about this change, please contact the Pension Policy team in HMRC at [email protected].