Navigating Recent Changes to the Lifetime Allowance, PCLS, and Death Benefits

The legislation to abolish the lifetime allowance has now been formally passed through Parliament. That’s one headache gone… isn’t it? Unfortunately not, whilst there will no longer be a punitive tax charge for exceeding a nominal limit, we are still going to have to bear that figure in mind because individuals will now be subject to a lump sum allowance and a lump sum and death benefits allowance. The upshot is, for exam candidates, a lifetime pension allowance remains very firmly part of the pension exam syllabus. This article is relevant for candidates who are studying towards the CII R04, FA2, J05 and AF7 exams.

This article is correct as at 10 October 2023.

New Allowances and How They Work

So what are these new allowances and how do they work in practice? Well, in summary, whilst the tax-free 25% PCLS is remaining, so is the limit on it. The limit will be based on the lifetime allowance in force at the time of its abolition. So individuals will usually be entitled to 25% of £1,073,100, or £268,275.

What’s more, a similar cap will be imposed on death benefits. As things currently stand, where a scheme member is aged under 75 at the age of death, any lump sum death benefits paid from their pension are usually paid free of tax. That is unless they happen to exceed the lifetime allowance, at which point a lifetime allowance excess tax charge will become payable based on the surplus.

Impact on Taxation

Whilst the proposals are obviously subject to potential change, it appears at the present time that this arrangement is going to be loosely retained. The main difference is that under the new regime, the surplus will be subject to income tax on the beneficiary as opposed to 55% lump sum/25% taken as income tax charge. In addition, the allowance available on the member’s death will be reduced by the value of any tax-free PCLS that they may have taken during their lifetime.

Allowance Protections

There are, however, also caveats to this. Where the member held lifetime allowance protection, then both allowances will be based on their protected amount. This means that the member will be able to take 25% of their protected limit as a tax-free pension commencement lump sum. Likewise, their beneficiaries will be able to take up to the protected amount free of any tax on death.

For those with enhanced protection, the allowance will be based around the original lifetime allowance of £1,500,000. This allows for a maximum tax-free PCLS of £375,000. The exception will be if the member also has lump sum protection. In this case, their entitlement will be based around their protected percentage, applied to the value of their pensions as at 5 April 2023.

Calculating Allowances

For example, a member with pensions valued at £2 million and lump sum protection of 40% would be entitled to receive a lump sum of £800,000 free of tax. Not a bad entitlement by today’s standards.

Interestingly, it appears that previous benefits taken as income will have no impact on the allowances. Previously, a PCLS was limited to the lower of 25% of the value of the benefits coming into payment, or 25% of the remaining lifetime allowance. Therefore, were a client to have used their full lifetime allowance by taking income, for example, a final salary scheme member who opted not to commute income for a PCLS, they could be in line for an unexpected windfall.

Potential Future Changes

Like (it seems) everything lifetime allowance related these days, the above proposals may well be refined prior to implementation. However, at least under today’s rules, that’s how it currently stands. Pension exam candidates would be well advised to keep an eye on the situation.

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