On 18 July 2023, HM Treasury and HM Revenue & Customs (HMRC) published draft legislation for inclusion in the draft Finance Bill 2023-2024, to implement two significant changes to the pension landscape. The draft legislation has been released prior to the formal introduction of the bill, allowing for a consultation process that concluded on 12 September. Each legislative measure comprises a policy paper, the actual text of the draft legislation, and an explanatory note that provides additional insights and clarification. The proposed measures for pensions include: the abolition of the lifetime allowance and the digitisation of the relief at source system. Below, we consider the key aspects of these proposed reforms and their implications for pension schemes.
Following the government announcement earlier in the year of its intention to abolish the lifetime allowance, discussed in our previous blog on the Spring Budget 2023, this legislation will complete the abolition of lifetime allowance.
Phasing Out the lifetime allowance:
The draft legislation will remove the lifetime allowance from pensions tax legislation, commencing in the 2024/25 tax year. This move follows the removal of the lifetime allowance charge in this tax year (2023/24). Provisions within the Finance Act 2004, which were directly linked to the lifetime allowance and lifetime allowance charge, are set to be repealed.
The interim provisions introduced by the Finance (No 2) Act 2023, disapplying the lifetime allowance charge and applying marginal-rate taxation on certain lump sums and lump sum death benefits for the 2023/24 tax year, will also be repealed.
Introducing New Allowances:
The draft legislation introduces changes to taxation rules for lump sums and lump sum death benefits. Key amendments include the introduction of a "lump sum and death benefit allowance" capped at £1,073,100 (the current level of the lifetime allowance), the removal of the lifetime allowance requirement for lump sum payments, and a new method for calculating maximum pension commencement lump sums.
Under the new method the maximum pension commencement lump sum will be the lesser of the member's "applicable amount" (typically 25% of their pension fund), their available "lump sum allowance" (with a maximum tax-free limit of £268,275), or their available "lump sum and death benefit allowance" (up to £1,073,100).
Payments exceeding the specified allowances will become subject to income tax at the recipient's marginal tax rate.
Safeguarding Transitional Protections:
While the lifetime allowance is being phased out, the draft legislation ensures the preservation of existing transitional protections. However, individuals holding enhanced protection will face limitations on their tax-free component for lump sums and death benefits.
Aligning Legislative Framework:
The Finance Act 2004 will undergo amendments to ensure it aligns with the digitisation of the relief at source system with effect from 6 April 2025.
The revamped system will accommodate different relevant tax rates, including the Scottish basic rate, Welsh basic rate, or the basic rate. This flexibility is designed to streamline the administration of tax relief on pension contributions.
Strengthening Compliance Measures:
Non-compliance with the new relief at source regulations will serve as grounds for the de-registration of a pension scheme. HMRC will also have the authority to impose additional consequences for non-compliance. These measures underscore the importance of adherence to the regulations and enhanced regulatory control over pension schemes.
New Regulations for Digitisation:
New regulations governing the relief at source system for eligible contributions from 6 April 2025 will be published for consultation in due course.
The existing regulations will continue to apply to contributions made until 5 April 2025, ensuring a phased transition to the new framework.
Association of Consulting Actuaries' Response
The Association of Consulting Actuaries (ACA) released a response to HMRC's consultation on the draft Finance Bill 2023-2024 over 2 letters. It emphasised the need for prompt finalisation of the legislation before 6 April 2024 to allow scheme administrators and members sufficient preparation time. ACA is also seeking clarification and further discussion on a number of matters including the policy intent behind the new lump sum allowances because they no longer restrict the size of the lump sums, just the tax-free amount and HMRC's interpretation of benefit crystallisation events, which could result in a significant policy change by having taxable pension income for beneficiaries of uncrystallised funds. ACA also recently released a third letter, which recommends a delay of 6 months to the implementation date and looks at the interaction of the legislation with regulations, guidance, and scheme rules.
Updates to HMRC Pensions Tax Manual
During the week commencing 5 September, 2023, HMRC made updates to the Pensions Tax Manual in response to legislative changes introduced by the Finance (No 2) Act 2023 and to be progressed with in the draft Finance Bill 2024. Key updates to the manual include: a new page explaining the removal of the lifetime allowance charge, adoption of marginal-rate taxation for specific lump sums and death benefits, and the impact on members; the addition of introductory pages summarising the new information on the lifetime allowance and transitional protections; and updates to existing information on the annual allowance.