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Pension lifetime allowance tax charge and its removal from April 2023

Introduction  

Prior to 6 April 2023 a lifetime allowance (LTA) charge applied where there wasn’t sufficient LTA to cover the value of the benefits being crystallised. A charge of a fixed percentage was levied against the pension in excess of the LTA before the remainder was paid to the member.  

The LTA charge has been abolished from 6 April 2023.  

For the 2023/24 tax year pension benefits that crystallise are still tested against the LTA. Any benefits that crystallise and exceed the LTA are subject to income tax when put into payment.
 

Core considerations 

  • The LTA charge has been abolished from 6 April 2023.  
  • The LTA charge applied when an individual crystallised benefits worth more than their LTA prior to 6 April 2023. 
  • Where the LTA charge applied it was levied as a 25% charge if pension benefits were drawn as an income, or 55% if drawn as a lump sum. 
  • During the member’s lifetime any charge will usually be deducted by the scheme and paid directly to HMRC. 
  • Where a LTA charge occured on death the charge must be paid by the beneficiaries.  
  • HMRC provides a significant amount of detailed guidance regarding the LTA, including examples, in section PTM080000 of the Pensions Tax Manual. 
     

Contents

 

Taxation of pensions in excess of the LTA from 6 April 2023

From 6 April 2023 any pension benefits that exceed the LTA when they crystallise will be subject to income tax at the member's marginal rate.  

  • Income 

Any benefits that exceed the member’s LTA that are taken as either an annuity, drawdown or a scheme pension will be fully taxed at the member’s marginal rate in the same way as any income taken below the LTA.  

The difference is that from 6 April 2023 there is no longer a 25% charge before the income is brought into payment.  

  • Lump sums 

Lump sums that would have been subject to the 55% LTA charge pre-6 April 2023 are now taxed at the recipient’s marginal rate. Because of this change none of the following lump sums fall under Accounting For Tax (AFT) reporting.  

For payments to a member this affects the payment of serious ill health lump sums, and the LTA excess lump sum.  

Serious ill health lump sums will now be tax free up to the LTA, with any excess taxed at the member’s marginal rate.  

LTA excess lump sums are only available before age 75 when a member has used all of their LTA. Any remaining uncrystallised benefits can be taken as a LTA excess lump sum, these lump sums will be taxed at the member’s marginal rate.  

For death benefits this change affects the beneficiaries of uncrystallised funds lump sum death benefit and the defined benefits lump sum death benefit. For these lump sums, when they are paid before age 75 and within 2 years of date of notification of death, they are paid tax free up to the LTA. Any of the lump sum that exceeds the LTA will initially be paid in full but will be taxable against the beneficiary’s marginal rate.  

The legal personal representatives of the estate must inform HMRC of the BCE’s and the recipients of those death benefits and how much they received. HMRC will then tax the recipients at their marginal rate.  

This remainder of this article sets out the points to consider for individuals where a LTA tax charge applied to benefits that crystallised pre 6 April 2023.
 

When and how the LTA tax charge applied before 6 April 2023

A LTA charge occurred when the individual’s total benefit crystallisation events exceed their LTA. If someone took benefits in stages, each BCE used up some of the available LTA. So, even if someone has uncrystallised rights over the LTA, the charge will only apply once they crystallise benefits in excess of their remaining LTA. 

As any uncrystallised funds are tested against the LTA at age 75 this is the latest point when a tax charge could occur.  

The LTA charge was 55% on any excess funds taken as a lump sum.   

Where the excess funds are used to provide an income (annuity, drawdown or scheme pension) the LTA charge was 25%. Any income payments will also be subject to an income tax charge as and when they are taken.  

In terms of deciding whether to take a lump sum or an income from the excess over the LTA, the overall tax position is broadly neutral where the income is paid to a higher rate taxpayer, as the overall rate of tax will also be 55% (25% charge, plus (40% of 75% = 30%) totals 55%).  

Where the LTA charge occurred due to the client reaching age 75, the charge was always at 25%. Any excess funds were then subject to income tax whether drawn as a one-off lump sum or taken as a regular income. Note, the LTA excess lump sum was not available after age 75.

The 25% charge also applied where any funds worth more than the LTA were transferred to a QROPs.
 

The LTA charge during lifetime

During lifetime, benefits will use up the member’s LTA in chronological order. Where more than one benefit crystallisation occurs at the same time, the member can choose the order of the crystallisations. However, where a pension commencement lump sum (tax free cash) is paid this is always treated as occurring before the associated annuity, drawdown or scheme pension payment.  

Where a LTA charge occurred and the member was still alive, the member and the scheme administrator were jointly and severally liable for the charge. This meant that the scheme administrator nearly always paid the tax charge, the charge would be deducted from the benefits and paid directly to HMRC.  

However, if the scheme administrator failed to do this because they've acted on incomplete or incorrect information provided by the member, their liability to the tax charge may be waived if they can show they acted 'in good faith'. In that case, liability for the charge would fall solely on the member. 

Even though the scheme administrator will normally pay the charge the member must complete a self-assessment tax return showing any excess benefits taken and how they were taken, along with the amount of tax paid by the scheme.
 

The LTA charge in the event of death

Where a LTA charge occurred because of the member’s death, the process for paying any charge differs from when a charge applied during their lifetime. On death the liability for the LTA charge falls solely on the beneficiary.  

The scheme administrator will pay the death benefits without deducting a LTA charge. This applies whether the funds are paid as a lump sum, designated as drawdown or used to purchase an annuity. 

The personal representatives of the deceased are responsible for determining whether a LTA charge applied.   

Where the personal representatives identify a LTA charge, they must report this to HMRC. HMRC will then assess the recipient of any charge due. The usual LTA charges will apply, i.e. 55% where payment is made as a lump sum or 25% where the funds are used to provide the beneficiary with income.  

Where there was more than one payment type or more than one beneficiary any LTA charge is apportioned between themLTALTA on a pro-rata basis. 

If the member believes that a LTA charge was not due or appropriate they can apply to HMRC to be discharged. Details of how to do so are available at: Discharging a LTA charge on GOV.UK.  

 

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