When the Chancellor of the Exchequer Jeremy Hunt announced the “abolition” of the Lifetime Allowance in the most recent Budget and other improvements such as the 50% increase in the annual allowance from £40,000 to £60,000 per person there was a collective cheer of relief from those most affected by the changes.
However, on closer examination of the small print, it was clear everything was not as rosy as it was painted in the Chancellor’s Budget speech. He has confirmed that the Lifetime Allowance will not apply for 2023/24.
However, the Lifetime Allowance hasn’t really been abolished. It still applies under certain circumstances on the occurrence of one of four so-called Benefit Crystallisation Events or BCEs for short when you can still be taxed at your marginal rate of up to 45% as opposed to the 55% tax rate for BCEs. There were thirteen BCEs previously which have been reduced to four, nonetheless, they still exist as does the Lifetime Allowance only it is not called that anymore. Semantics methinks.
Another factor to consider is that the Lifetime Allowance won’t actually be abolished until next year’s Finance Bill is enacted as the Finance Act in the 2024/25 tax year. The problem is that the Labour Party has already announced their intention to re-introduce the Lifetime Allowance if they win the next General Election which is highly likely to occur next tax year after the Finance Act becomes law and Labour is well ahead of the Tories in the polls and odds on favourites to win the election. It is on this basis that I continue to advise clients on the assumption that the Lifetime Allowance will not be actually abolished after all. This means that the current tax year offers the best opportunity to potentially avoid it altogether. This will be the subject of my next blog!
Crucially the tax free cash lump sum has now been frozen at a maximum of 25% of the previous Lifetime Allowance limit of 25% of £1,073,100 which is £268,275. This concerns me because I wouldn’t be at all surprised if this limit is never increased again. There are many reliefs and allowances which have been frozen for decades. I suspect this is the latest in a long line of them. It would appear to be one way of funding the tax lost from the “abolition” of the Lifetime Allowance tax charge.
Most people just think they are entitled to this tax free lump sum monetary amount and that’s the end of it but it isn’t quite that simple. Pensions are notoriously complex and the intricacies of the so-called Pension Commencement Lump Sum or PCLS are no exception.
What happens is that every time you withdraw tax free cash from your pension the amount you withdraw or crystallise (100%) is computed as a percentage of all of your pensions and it is that percentage which is deducted from your Lifetime Allowance rather than the monetary amount as such.
What this means is that under certain circumstances you may never actually withdraw the full 25% PCLS based on the most recent Lifetime Allowance amount.
One way in which this can happen is if the Lifetime Allowance increases over time. As an example let’s assume the LTA is £1m and you crystallise £500,000 resulting in a £125,000 PCLS. If the LTA were to increase to, say, £2 million, you would only be able to crystallise £1 million (50%) and a maximum PCLS of £250,000 meaning the total PCLS you could take would be £375,000 (£125,000 + £250,000) instead of £500,000 (£2 million x 25%).
If you defer taking your full 25% tax free cash lump sum (PCLS) and you already have a large pension worth say £1 million and it trebles in value to £3 million then the maximum PCLS you can take is £268,275, the new frozen limit, instead of £750,000 (25% x £3 million). That’s a maximum tax free cash lump sum of just under 9%. Ouch!
If you were to decide to focus on withdrawing the PCLS in stages over the first few years of your retirement and take no income, especially if you no longer pay into that pension, then you may find that you never manage to withdraw the maximum tax free cash lump sum from your scheme. Let me illustrate this with an example.
You currently have a pension worth £800,000. You have withdrawn £200,000 in tax free cash lump sums (PCLSs) previously. This means you have crystallised £800,000 of benefits from your scheme to achieve PCLSs of £200,000. Your pension has also fallen in value. If you now wish to take a further tax free cash lump sum you cannot do so because the maximum amount allowable is £200,000 (£800,000 x 25% = £200,000 – £200,000 withdrawn previously = £0). So the balance of the maximum allowable PCLS of £68,275 (£268,275-£200,000) cannot be withdrawn until your pension is worth at least £1,073,100. 25% of this figure is £268,275.
There is a lot of number crunching going on in this blog but the main takeaway is that you may never manage to withdraw the maximum tax free cash lump sum from your pension because of the various traps. In order to avoid these traps you should consult an experienced and knowledgeable Independent Financial Adviser for advice. You know it makes sense.*
The value of investments can fall as well as rise. You may not get back what you invest. The information contained within this blog is for guidance only and does not constitute advice which should be sought before taking any action or inaction. All information is based on our current understanding of taxation, legislation, regulations and case law in the current tax year. Any levels and bases of relief from taxation are subject to change. Tax treatment is based on individual circumstances and may be subject to change in the future. This blog is based on my own observations and opinions.