Policy paper

Explanatory note (accessible version)

Updated 18 July 2023

Clause 1: Registered Pension schemes

Summary

1. This measure abolishes the Lifetime Allowance (LTA) and sets out the new tax treatment of lump sums and lump sum death benefits paid from registered pension schemes. The changes have effect on or after 6 April 2024.

Details of the Schedule

Schedule 1: Part 1: Abolition of the LTA Charge

2. Schedule 1, Part 1 amends the necessary provisions of Finance Act 2004 as a result of the abolition of the LTA.

Schedule 1: Part 2: Taxation of Lump Sums

3. This Part sets out the tax treatment of lump sums and lump sum death benefits in the absence of the LTA.

4. Paragraphs 18 to 20 make consequential changes to the lump sum rules and lump sum death benefit rules in Finance Act 2004 following the abolition of the LTA.

5. Paragraph 21 ensures that lump sum death benefits are not considered when calculating income deducted for the purposes of the Tapered Annual Allowance.

6. Paragraph 22 removes references to benefits which are no longer payable.

7. Paragraph 24 makes consequential changes to Finance Act 2004, reflecting the provision now contained in Income Tax (Earnings and Pensions Act) 2003 (ITEPA). Paragraph 24(7) ensures that the existing anti-avoidance rules relating to pension commencement lump sums (PCLS) continues to operate as it currently does in relation to the different types of pension arrangements.

8. Paragraphs 25 to 27 make the necessary changes to Finance Act 2004 to reflect that these provisions are now contained in ITEPA.

9. Paragraphs 28 amends paragraphs 7 and 8 of Schedule 29 Finance Act 2004 to maintain the current limits on trivial commutation lump sum payments. Paragraph 28(3) provides a regulation making power to His Majesty’s Revenue and Customs (HMRC) to specify how an entitlement to benefits is to be valued for the purposes of trivial commutation lump sums.

10. Paragraphs 29 to 33 make the necessary changes to Finance Act 2004 to reflect that these provisions are now contained in ITEPA.

11. Paragraphs 34 to 36 make technical changes to reflect the substitution of existing Chapter 15A ITEPA with new Chapter 15A in ITEPA.

12. Paragraph 37 substitutes Chapter 15A of ITEPA with new Chapter 15A of ITEPA:

Chapter 15A

13. Section 637A provides that a PCLS is free of income tax provided it does not exceed the lowest of the applicable amount (which is defined in section 637N to section 637S), the amount that remains available of the lump sum allowance (which is defined at section 637T) and the amount remaining available of the lump sum and death benefit allowance (which is defined in section 637V).

14. Section 637B provides that a serious ill-health lump sum is tax free provided it is paid to someone under the age of 75 and does not exceed the permitted maximum. The permitted maximum is defined at subsection (3) as the amount that remains available of the lump sum and death benefit allowance. Subsection (4) provides that where the serious ill-health lump sum is paid to someone aged 75 or over the lump sum is taxed as if it were pension income.

15. Section 637C provides that so as long as 25% of an uncrystallised funds pension lump sum is within the permitted maximum, it is tax free and the remaining 75% is taxed as if it were pension income. Subsection (2) provides that where some part of the 25% would exceed the permitted maximum, it is taxed as if it were pension income. Subsection (3) defines the permitted maximum as the lower of the amount remaining available of both the lump sum allowance and the lump sum and death benefit allowance.

16. Section 637D provides that a short service refund lump sum paid under a registered pension scheme is taxable only under section 205 of Finance Act 2004.

17. Section 637E provides that a refund of excess contributions lump sum is not subject to income tax when paid under a registered pension scheme.

18. Section 637F provides that a trivial commutation lump sum or winding-up lump sum may have a tax-free element. The tax-free element is the lowest of 25% of the lump sum, the available amount of the individual’s lump sum allowance or the available amount of the individuals lump sum and death benefit allowance. The remainder is taxed as if it were pension income.

19. Section 637G provides that a defined benefit lump sum death benefit is tax free where it is paid within 2 years of the relevant period in respect of a member who died under the age of 75 and does not exceed the permitted maximum. Subsections (2) to (6) set out the circumstances in which some or all of the defined benefit lump sum death benefit will be subject to a tax charge. Subsection (7) defines the terms used within section 637G.

20. Section 637H provides that a pension protection lump sum death benefit is tax free in respect of a member who died under the age of 75 and does not exceed the permitted maximum. Subsections (2) to (6) set out the circumstances in which some or all of the pension protection lump sum death benefit will be subject to a tax charge. Subsection (7) defines the terms used within section 637H.

21. Section 637I provides that an uncrystallised funds lump sum death benefit is tax free where it is paid within 2 years of the relevant period in respect of a member who died under the age of 75 and does not exceed the permitted maximum. Subsections (2) to (6) set out the circumstances in which some or all of the uncrystallised funds lump sum death benefit will be subject to a tax charge. Subsection (7) defines the terms used within section 637I.

22. Section 637J provides that an annuity protection lump sum death benefit is tax free in respect of a member who died under the age of 75 and does not exceed the permitted maximum. Subsections (2) to (4) set out the circumstances in which some or all of the annuity protection lump sum death benefit will be subject to a tax charge. Subsection (5) defines the terms used within section 637J.

23. Section 637K provides that a drawdown pension fund lump sum death benefit is tax free where it is paid within 2 years of the relevant period in respect of a member who died under the age of 75 and does not exceed the permitted maximum. Subsections (2) to (6) set out the circumstances in which some or all of the drawdown pension fund lump sum death benefit will be subject to a tax charge. Subsections (7) and (8) define the terms used within section 637K.

24. Section 637L provides that a flexi-access drawdown lump sum death benefit is tax free where it is paid within 2 years of the relevant period in respect of a member who died under the age of 75 and does not exceed the permitted maximum. Subsections (2) to (6) set out the circumstances in which some or all of the flexi-access drawdown funds lump sum death benefit will be subject to a tax charge. Subsections (7) and (8) define the terms used within section 637L.

25. Section 637M provides that where a trivial commutation lump sum death benefit is paid from a registered pension scheme it is treated as taxable pension income for the tax year it is paid.

26. Section 637N defines applicable amount for the calculation of an individual’s PCLS where the relevant pension is income withdrawal as one third of the value of the amount designated to drawdown, not including any disqualifying pension credit, which is defined at section 637X.

27. Section 637P provides that the applicable amount for the purposes of a lifetime annuity is one third of the annuity purchase price. Subsection (3) sets out that the annuity purchase price is the aggregate of the amount held for the scheme and the market value. Subsection (4) sets out that deductions from the applicable amount are made in respect of any disqualifying pension credit.

28. Section 637Q provides the calculation for the applicable amount for the purposes of a scheme pension under a defined benefits arrangement. Subsection (3) sets out that in calculating the amount payable to an individual in a 12-month period any abatement under a public service pension should not be taken into account.

29. Section 637R provides that section 637Q applies equally in relation to a collective money purchase arrangement.

30. Section 637S provides that where accrued rights are subject to a relevant surrender or transfer, with the purpose of increasing the applicable amount on becoming entitled to a scheme pension, the applicable amount is reduced by any amount if the arrangement was a money purchase arrangement.

31. Section 637U provides how to establish the amount available of an individual’s lump sum allowance, the total value of which is set out in Section 637T. Where there have been no relevant benefit crystallisation events, defined in subsection (2) as an individual becoming entitled to a relevant lump sum, the whole lump sum allowance is available. Where there has been a relevant benefit crystallisation event, the allowance available is reduced by the total of the non-taxable amounts in relation to each lump sum to which the individual has become entitled.

32. Section 637W provides how to establish the amount available of an individual’s lump sum and death benefit allowance, the total value of which is set out in section 637V. Where there have been no relevant benefit crystallisation events, defined in subsection (2) as an individual becoming entitled to an authorised lump sum or a person becoming entitled to a lump sum death benefit, the whole lump sum and death benefit allowance is available. Where there has been a relevant benefit crystallisation event, the allowance available is reduced by the total of the non-taxable amounts of any lump sum or lump sum death benefit to which someone has become entitled. Subsection (7) and (8) make specific provision for the sequencing of relevant benefit crystallisation events.

33. Section 637X defines disqualifying pension credit for the purposes of new Chapter 15A ITEPA 2003.

34. Section 637Y defines related to for the purposes of new Chapter 15A ITEPA 2003.

35. Paragraph 38 of Schedule 1, Part 2, Taxation of Lump Sums makes consequential amendments to the Registered Pension Schemes (Authorised Payments) Regulations 2009 (S.I. 2009/1171).

Schedule 1: Part 3: Transitional Protections

36. Paragraphs 39 to 41 make consequential amendments to the legislation on transitional protections following the abolition of the LTA.

37. Paragraph 42 replaces paragraph 7 (primary protection) of Schedule 36 to Finance Act 2004. It increases an individual’s lump sum allowance to maintain their entitlement to tax-free cash at the same level as prior to the abolition of the LTA. This section also provides that an individual’s lump sum and death benefit allowance is increased to the value of their pension rights at 5 April 2006 where they hold primary protection. Subsection (8) sets out that an individual cannot receive an uncrystallised funds pension lump sum (UFPLS) where they have primary protection and on 5 April 2006 their total lump sum rights exceeded £375,000, or where they have primary protection, and their lump sum allowance is 25% or less of the UFPLS.

38. Paragraph 43 amends paragraph 11 of Schedule 36 to Finance Act 2004. It provides that an individual’s lump sum and death benefit allowance is reduced where they hold primary protection but have become subject to pension debit on or after 6 April 2006.

39. Paragraph 44 amends paragraph 11A of Schedule 36 to Finance Act 2004. This provides for an increase in an individual’s lump sum and death benefit allowance where the payment of certain death benefits exceeds this allowance due to the primary protection factor being reduced as a result of pension debits.

40. Paragraph 45 amends paragraph 12 (enhanced protection) of Schedule 36 to Finance Act 2004. It defines the permitted maximum for the lump sums and lump sum death benefits contained within new Chapter 15A ITEPA 2003 for those who have enhanced protection. Sub-paragraph (3E) provides HMRC with a regulation making power to provide the detail on how pension schemes will value uncrystallised pension rights.

41. Paragraph 46 makes consequential changes to the legislation on enhanced protection following the abolition of the LTA.

42. Paragraph 47 replaces paragraph 18 (pre-commencement pension credits) of Schedule 36 to Finance Act 2004. It provides that an individual’s lump sum allowance is the lowest of the £268,275 (the lump sum allowance) increased by the pension credit factor, or £375,000. This section also increases an individual’s lump sum and death benefit allowance where they became entitled to pension credits before 6 April 2006. This effectively maintains their entitlements prior to the abolition of the LTA.

43. Paragraph 48 amends paragraph 19 (individuals permitted to take pension before normal minimum pension age (NMPA)) of Schedule 36 to Finance Act 2004. This replicates the existing provisions relating to an individual who takes pension benefits prior to NMPA and has a protected pension age of less than 50. It reduces the lump sum allowance and their lump sum and death benefit allowance only when lump sums are taken.

44. Paragraphs 49 to 52 makes consequential changes to the legislation on pre-commencement pensions and benefit rights following the abolition of the LTA.

45. Paragraph 54 amends paragraph 28 (lump sum rights exceeding £375,000: primary and enhanced protection) of Schedule 36 to Finance Act 2004 so that, for individuals with primary protection, their permitted maximum for PCLS is the value of the individual’s relevant uncrystallised lump sum rights on 5 April 2006 less the value of any previous PCLS taken. Subject to any adjustments as laid out in sub-paragraphs (4) and (5).

46. Paragraph 55 amends paragraph 29 (lump sum rights exceeding £375,000: primary and enhanced protection)) of Schedule 36 to Finance Act 2004 so that, for individuals with enhanced protection, their applicable amount for a PCLS is the amount that could have been paid on 6 April 2023 and includes details of how schemes should value different types of pension arrangement. It includes a regulation making power for HMRC to specify how schemes should value crystallised pension rights.

47. Paragraph 56 makes consequential changes to ensure that where an individual held enhanced protection with lump sum rights greater than £375,000, their lump sum allowance is the amount which could have been paid on 5 April 2023.

48. Paragraph 58 makes consequential changes to the legislation on transitional protections following the abolition of the LTA.

49. Paragraph 59 amend paragraphs 34 of Schedule 29 Finance Act 2004 (entitlement to lump sums exceeding 25% of uncrystallised rights) to ensure that the permitted maximum is maintained at the level the individual had prior to the abolition of LTA.

50. Paragraph 61 amends paragraph 14 (fixed protection) of Schedule 18 of Finance Act 2011. This provides for an individual’s lump sum allowance to be increased to £450,000 where they hold fixed protection. It also provides for their lump sum and death benefit allowance to be £1,800,000. This effectively maintains their entitlements prior to the abolition of the LTA.

51. Paragraph 62 amends Part 1 (fixed protection 2014) of Schedule 22 of Finance Act 2013. This provides for an individual’s lump sum allowance to be increased to £375,000 where they hold fixed protection 2014. It also provides for their lump sum and death benefit allowance to be to £1,500,000. This effectively maintains their entitlements prior to the abolition of the LTA.

52. Paragraph 63 amends Part 1 (individual protection 2014) of Schedule 6 of Finance Act 2014. This provides for an individual’s lump sum allowance to be increased to the lesser of £375,000 and 25% of the value of their pension rights on 5 April 2014, where they hold individual protection 2014. It also provides for their lump sum and death benefit allowance to be the lesser of £1,500,000 and the value of their pension rights on 5 April 2014. This effectively maintains their entitlements prior to the abolition of the LTA.

53. Paragraph 64 amends Part 1 (fixed protection 2016) of Schedule 4 of Finance Act 2016. This provides for an individual’s lump sum allowance to be increased to £312,000 where they hold fixed protection 2016. It also provides for their lump sum and death benefit allowance to be £1,250,000. This effectively maintains their entitlements prior to the abolition of the LTA.

54. Paragraph 65 amends Part 2 (individual protection 2016) of Schedule 4 of Finance Act 2016. This provides for an individual’s lump sum allowance to be increased to the lesser of £312,000 and 25% of the value of their pension rights on 5 April 2016, where they hold individual protection 2014. It also provides for their lump sum and death benefit allowance to be the lesser of £1,250,000 and the value of their pension rights on 5 April 2016. This effectively maintains their entitlements prior to the abolition of the LTA.

55. Paragraph 66 provides for an application deadline for fixed and individual protection 2016 of 6 April 2025.

Schedule 1: Part 4: Commencement and Transitional Provision

56. Schedule 1 Part 4 provides a placeholder for the transitional arrangements where members have taken some benefits whilst the LTA existed. These do not form part of the clauses published at L-Day.

Background note

57. The LTA was the maximum amount of tax relievable pension savings an individual could benefit from over the course of their lifetime. At Spring Budget 2023, the government announced that it would abolish the LTA. The first stage of this was achieved through Finance (No.2) Act 2023. This measure completes the abolition of the LTA following the removal of the LTA charge, to support the government’s efforts to encourage individuals to return to work.

58. Protections were available to individuals each time the LTA was reduced, to ensure they were not disadvantaged by the reductions. A Benefit Crystallisation Event (BCE) was a specific occasion when the value of pension benefits arising (crystallising) were measured against the LTA. A BCE also occurred when a pension scheme member reached age 75.

59. This measure establishes a lump sum allowance and a lump sum and death benefit allowance. The lump sum allowance maintains the amount of tax-free cash individuals can receive at the same level as applied previously. The lump sum and death benefit allowance ensures that where the total value of lump sums or lump sum death benefits exceed the limit, individuals will pay marginal rate tax on the excess.

60. Regular pension income will not be tested against these allowances, and there will be no limit on the size of authorised lump sums and lump sum death benefits, only a limit on the amounts not subject to income tax.

61. If you have any questions about this change, or comments on the legislation, please email Catherine Batey at [email protected].

Benefit Crystallisation Event (BCE