What challenges do the new LTA rules pose?

This came into effect on April 6 2023 and is a precursor to a full dismantling of the LTA in 2024-25.

With the draft legislation published and a few updates issued by HMRC on some of the mechanics, it is worth looking at what this means in practice for clients with pensions in excess of the LTA in the following scenarios:

• Taking pension benefits during their lifetime.
• Age 75.
• Benefits paid out on death.

Recap of the 2022-23 rules

First, though, a quick reminder of how the LTA charge operated.

The standard LTA in 2022-23 was £1,073,100, although it has been increased and decreased at various times since its introduction in 2006.

If an individual took pension benefits in excess of the LTA, the rules gave them three options for dealing with the excess:

1. Receive the excess as a lump sum, subject to a 55 per cent LTA charge.
2. Keep the excess in the pension scheme and use it to provide a form of income, subject to a 25 per cent LTA charge.
3. A combination of points one and two.

The lower charge in option two is due to the fact that pension income would be subject to income tax. A higher rate taxpayer, for example, would likely see a broadly similar outcome either way in terms of overall tax paid. 

At age 75 BCE (benefit crystallisation events), only option two was available. 

Scrapping the LTA charge

From April 6 2023, however, no LTA charge can arise in any scenario. This is described in the explanatory notes to the legislation as a freestanding provision.

Simply put, any time there is an LTA excess in the 2023-24 tax year, there will not be an LTA charge. That excess can now be dealt with in different ways, which is what we will cover in this article.  

The government intends this as a temporary measure while it considers how to fully weed out the LTA.

We are expecting a consultation later this year on the rules for 2024-25 and beyond. If for any reason the process does not yield a new set of rules, the current rules remain in place.

For some clients this change is a real windfall, and I have seen examples from advisers where clients are saving hundreds of thousands of pounds.

There is a slight twist to the tale, however, given that certain lump sums are now taxed at the recipient’s marginal rate of income tax if the client has used all of their LTA. These are the lump sums in question:

• LTA excess lump sum.
• Serious ill-health lump sum.
• Defined benefits lump sum death benefit.
• Uncrystallised funds lump sum death benefit.

Taking benefits during the client’s lifetime 

In terms of the practical impact, let’s look at a client who has uncrystallised funds but insufficient LTA to cover those funds.

The LTA still exists in 2023-24 and is still £1,073,100. Therefore, if your client is taking benefits this tax year, their pension provider will still ask for information on LTA usage under other schemes.

On the face of it, clients might wonder why their provider is doing this if the charge is being scrapped.