09 OCT 2023

Life-time allowance changes and the PCLS stealth tax

The announcement in this year’s budget that the lifetime allowance was being removed and with it the hefty charge on large pension funds, was largely cheered by industry. However, as with most things the devil, as they say, is in the detail and hidden beneath the headline announcement was in effect another stealth tax.

The chancellor announced that the life-time allowance was being abolished in April 2024, but that the pension commencement limit would remain at 25% of the last published life-time allowance, the exception being those cases where some form of enhanced or fixed protection existed.

Admittedly the life-time allowance was frozen and likely to remain so for several years to come, but since it was reduced to £1,000,000 in 2016 it had generally been revised in an upward direction in line with rises in prices.

The April 2023 budget announcement effectively freezes the pension commencement lump sum limit for all eternity, at £268,275. With the consumer price index currently at 6.8% (RPI in July was 10.9%) this means a swift erosion in the purchasing power of that tax-free cash sum, as the years pass.

For anyone approaching their 55th birthday this therefore means some serious thought must be given on whether to take the lump sum now or wait.

Case Study

Anika is approaching 55.  She has a very decent sized DC pension worth £1,100,000. She is still making personal contributions and does not want to retire yet. She is worried about the lifetime allowance changes and the effect on her lump sum.

Anika consults her financial adviser, who informs her that one option available is to crystallise her pension pot now. She can take her tax-free cash sum (limited to £268,275) and designate the remaining sum to drawdown. The chancellor’s budget has increased the money purchase annual allowance, meaning that she can still make contributions of up to £10,000 per tax-year. The pension funds designated to drawdown can remain invested until she decides to draw an income from them.

Perhaps best of all however, she has choices with her tax-free cash sum. Although she cannot recycle that money by investing it back into a pension, she can choose to invest it elsewhere in a different tax wrapper if she does not need the funds, thereby safeguarding a substantial sum of money against the erosion of inflation, which is currently at levels not seen since the early 1980s.

Alternatively, she might decide she wants to invest that lump sum in property, or something else which can provide her with either a monetary or personal benefit.

There is one caveat and this is once the tax-free cash sum has been removed from the pension trust environment it can become liable for inheritance tax, depending on how it used. This obviously needs careful consideration. The Chancellor’s autumn statement is also likely to provide detail on the 2024 life-time allowance changes so more changes to the pension tax regime may be on their way.

This aside, we definitely recommend a conversation with a financial adviser for anyone who finds themselves in a similar position to Anika.  The new post life-time allowance world needs careful navigation!