UK pensions lifetime allowance limbo: what you need to know

HMRC has tried to be helpful, with various pension newsletters and FAQs commenting on the outstanding issues.   Fixing these has been put on hold (at least publicly) by the General Election.  We must now wait and see whether – and how quickly – regulations to correct the remaining anomalies will be taken forward by the next government.   

In the meantime, some members with high levels of benefits may be better off delaying taking their benefits, or delaying a transfer to a non-UK scheme, until new regulations are introduced or the position is otherwise clarified.

Who is affected by the limbo?

• Some individuals with lifetime allowance (LTA) protection
• Personal representatives (PRs) of deceased members where certain death benefit lump sums are to be paid
• Some members wishing to transfer overseas to a QROPS
• Administrators having to deal with the new system

What this note covers 

In this note we look at the following areas where further legislation is awaited (or needed):

• Lifetime allowance (LTA) restrictions in scheme rules
• Some transitional anomalies for members with enhanced or primary protection
• Scheme specific lump sum protection: technical errors
• Death benefit lump sums from pre-L Day crystallised defined contribution (DC) funds
• Some gremlins with overseas transfers
• Outstanding quirks with transitional tax-free amount certificates (TTFACs): challenges for administrators

This note is based on statements made by HMRC before the General Election was called.  Of course, a future government may choose not to take forward some or all of the legislative corrections previously highlighted by HMRC.

Lifetime allowance (LTA) restrictions in scheme rules 

Some scheme rules limit benefit accrual by reference to the LTA.  Typically, above LTA-benefits might be provided for higher earners through an unregistered top-up scheme.

The concern was that, on removing the LTA from legislation, affected members would gain a windfall as their benefits would be no longer limited by reference to the LTA.

To avoid such windfalls, the March regulations preserve the effect of references to the LTA (or the LTA charge) in scheme rules.  Unfortunately, the regulations don’t help if a scheme’s rules restrict benefits by reference to loss of fixed or enhanced protection. 

The impact of the regulations on particular rules will depend on the specific wording of those rules; trustees who are concerned should take advice.

Trustees should also note that the override will fall away from 6 April 2029 – meaning that rule amendments will be needed to retain the effect of any LTA references after that date.   The government has been urged to bring in a statutory modification power to help schemes with restrictive amendment powers.

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Some transactional anomalies for members with enhanced or primary protection

As a reminder, members with significant pension benefits prior to April 2006 could opt to protect those savings against the (then) new Lifetime Allowance (LTA), by registering with HMRC for “enhanced protection” (EP) and / or “primary protection” (PP). 

If a member with EP or PP had rights at 5 April 2006 to lump sums of more than £375,000 (25% of the LTA at introduction), those rights to enhanced lump sums were protected.

Enhanced or primary protection: protected tax-free cash limited to £375,000

HMRC is concerned that since L-Day, a member with enhanced protection (EP) or primary protection (PP) and rights to a protected lump sum of over £375,000 may not take a protected PCLS (tax-free cash) of more than £375,000.  The policy intention, however, is for such individuals to be able to take a PCLS to the level of their previous protection.

Future legislation is expected to:

• Amend existing provision to allow affected members to take a higher protected PCLS.

In the meantime:

• HMRC recommends that affected members may wish to delay taking a PCLS (or limit the amount of PCLS taken to £375,000).

Enhanced protection: transferring to a new provider

Individuals with enhanced protection (EP) cannot currently transfer to another provider without losing their EP.  This is an anomaly in the legislation, since the restriction on transfers for individuals with EP was removed as part of the LTA changes announced by the Chancellor of the Exchequer in March 2023.  HMRC states that the policy intention is for EP members to continue to be able to transfer without losing protection.

Future legislation is expected to:

• Allow members with EP to transfer to a new provider without losing their protection (except if the individual applied for EP after 15 March 2023).

In  the meantime:

• Members with EP may wish to delay transferring to a new arrangement until the new legislation is in force.

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Scheme specific lump sum protection: technical errors 

Some members have protected lump sum rights under their scheme rules, which enable them to take a pension commencement lump sum (PCLS) greater than the usual 25% of the pension value.  Such rights are specific to their particular scheme and relate to pre-April 2006 service. 

HMRC has pointed out that the legislation contains technical errors relating to:

• Certain benefits being double counted;
• Calculating the correct reduction to a member’s lump sum allowance (LSA) when the member takes a PCLS; and
• Ensuring the level of remaining lump sum protection is calculated correctly following a partial transfer of the member’s rights to a new provider.

Future legislation is intended to:

• Remedy the above technical errors.

In the meantime:

• HMRC suggests that members may wish to delay taking tax-free cash (PCLS) under scheme specific lump sum protection.
• HMRC comments that members with scheme-specific lump sum protection, and who wish to transfer part of their rights to another scheme, should be able to do so before the amending legislation has effect.  However, the member may want to delay taking a PCLS from their original (protected) arrangement until after the corrections are made.

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Death benefit lump sums from Pre-L Day crystallised defined contribution (DC) funds 

Death benefit lump sums: unintended tax liability 

Where a lump sum death benefit is paid from DC funds which crystallised before L-Day (for example, DC funds which the member designated for drawdown before 6 April 2024), the policy intent is for those lump sum death benefits to be paid fully tax free and not trigger a deduction from the member’s lump sum and death benefits allowance (LSDBA).

At present, an unintended gremlin in the tax legislation means that if any of the lump sum death benefit exceeds the member’s available LSDBA, the excess will be liable to income tax.

Future legislation is expected to:

• Provide that lump sum death benefits paid from funds which crystallised pre-L Day will be fully tax free.

In the meantime:

• Personal representatives (PRs) of a deceased member may wish to delay requesting payment of lump sum death benefits from pre-L Day crystallised funds.

Pre-L Day crystallised funds: risk of losing tax status on transfer 

A scheme transferring DC funds is not currently required to notify the receiving scheme if the transferring pot includes rights which crystallised before L-Day.  This matters because, should the member die, any lump sum death benefit from those pre-L Day crystallised funds should be paid tax free – but the administrator of the new scheme may not realise that the funds crystallised before L-Day.

Future legislation is expected to:

• Require a transferring scheme to notify the receiving scheme of any pre-L Day crystallised funds included in the transfer, with retrospective effect from 6 April 2024.

In the meantime:

• On a transfer of pre-L Day crystallised funds, the transferring administrator should provide this information to the receiving administrator anyway.
• On a member’s death, well-advised PRs should check the status of any crystallised DC funds, where relevant.

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Some gremlins with overseas transfers 

Reminder: new overseas transfer allowance (OTA) 

From 6 April 2024, a new overseas transfer allowance (OTA) can apply where a member transfers benefits from a UK registered pension scheme to a qualifying recognised overseas pension scheme (QROPS).  Unless the member has LTA protection, the OTA will be £1.073m (the same as the standard lump sum and death benefit allowance (LSDBA)), less:

• If the member had any benefit crystallisation events before L-Day, the amount of LTA used by those BCEs; plus
• The amount of any earlier transfer to a QROPS (or onward transfer to a different QROPS) which takes place after L-Day.

Broadly, if the value transferred to an overseas arrangement exceeds the member’s available OTA, the excess will be subject to an overseas transfer charge of 25%.  (In certain circumstances, the overseas transfer charge applies to the whole amount transferred.)

Transferring a drawdown fund to a QROPS: double deduction from OTA 

Where a member designated defined contribution (DC) funds for drawdown before L-Day, the amount crystallised is deducted from the member’s overseas transfer allowance (OTA).   However, if the member subsequently transfers the drawdown fund to a QROPS, the amount of the fund being transferred will also be deducted from the member’s OTA.  In other words, the member suffers a double reduction to their OTA.

Future legislation is expected to:

• Remove the double counting, so that a fund designated for drawdown and subsequently transferred to a QROPS is only deducted once from a member’s OTA.

In the meantime:

• Affected members may wish to delay transferring a fund already designated for drawdown to a QROPS.

Overseas transfer allowance: pre-A Day benefits not deducted 

A further quirk means that any benefits crystallised before 6 April 2006 (A-Day) are only taken into account in the member’s OTA if the member also crystallised benefits between  A-Day and L-Day.

Future legislation is expected to:

• Provide that the reduction to an individual’s OTA takes account of pre-A Day benefit crystallisation events.

In the meantime:

• HMRC suggests that affected members may wish to delay transferring to a QROPS until the legislation is changed.  This suggests that the amendments are intended to have retrospective effect from L-Day.

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Outstanding quirks with transitional tax-free amount certificates (TTFACs): challenges for administrators

Reminder: what is TTFAC? 

Many benefits taken from registered schemes before L-Day must be taken into account and will reduce a member’s available lump sum allowance (LSA) and/or lump sum and death benefits allowance (LSDBA). There are two ways of calculating how much is to be deducted:

• The default method which, broadly, deducts 25% of the value crystallised for lifetime allowance (LTA) purposes before L-Day; and
• The bespoke method which, broadly, takes account of lump sums actually taken tax-free before L-Day, based on evidence supplied by the member.

A member who wishes to use the bespoke method may apply to their scheme for a “transitional tax-free amount certificate” (TTFAC) and, provided the member supplies the required information, the scheme administrator must provide a certificate within three months, showing the amount to be deducted from the member’s LSA or LSDBA.

Reminder: why use a TTFAC? 

For the majority of members, the default method will be sufficient, either because their total lump sums are considerably less than the maximums allowed, or because they chose to take their maximum 25% tax free cash.

Using the TTFAC bespoke method may be advantageous for members with significant pension savings who did not take the maximum tax-free cash on their pre-L Day benefit crystallisation event.  In practice, this is most likely to be members of defined benefit (DB) schemes who chose not to commute part of their DB pension for tax-free cash (PCLS).

If a member has a TTFAC, then using the default calculation to take account of pre-L Day benefits is no longer allowed.

Not all members will be better off with a TTFAC.  Members should therefore consider carefully before applying for a TTFAC as this decision cannot be reversed.

How will you know that a member has a TTFAC? 

A member with a TTFAC does not, currently, have to notify this to any other schemes in which s/he has remaining rights. 

However where a member has a TTFAC in force and, after L-Day, wants to take a lump sum benefit from your scheme (so triggering a relevant benefit crystallisation event), you must use the TTFAC (and not the default transitional method) to calculate the member’s available lump sum allowance (LSA) and lump sum and death benefit allowance (LSDBA).  

Trustees who did not know that a member has a TTFAC may have mistakenly used the default calculation method for taking account of pre-L Day benefits – HMRC has said it recognises that such schemes will have acted on the information available to them.

Future legislation is expected to:

• Require a member with a TTFAC to provide a copy of this to any other schemes in which s/he has remaining rights;
• Require such a member to notify his/her other schemes if the TTFAC is cancelled; and
• On a buyout or transfer to another scheme, require the trustees or administrator of the transferring scheme to notify the receiving scheme or annuity provider of any TTFACs held by affected members.

In the meantime:

• Trustees may wish to add a question to their pre-retirement paperwork, asking members to confirm whether or not they have (or have applied for) a TTFAC.

What if a TTFAC is found to be wrong? 

If a scheme administrator realises that the transitional tax-free amount stated in a member’s TTFAC is wrong, the administrator must cancel the TTFAC by giving notice to the member.  If a relevant benefit crystallisation event (RBCE) has occurred in relation to the member before the TTFAC is revoked, the RBCEs must be recalculated using the corrected  transitional tax-free amounts.  The member may then be liable for additional tax.

Some lump sums (including a pension commencement lump sum (PCLS), trivial commutation lump sum and winding up lump sum) may only be paid if the member has some available lump sum allowance (LSA).  If the recalculation of the member’s transitional tax-free amount shows that the member had no LSA available when the benefits were taken, those benefits would have been unauthorised payments.  Under current legislation, this would mean that an unauthorised payments tax charge is payable.

Future legislation is expected to:

• Provide that lump sums paid in reliance on a TTFAC which is subsequently revoked, and which would otherwise be unauthorised payments, will not be treated as unauthorised.  Instead, the lump sums will be fully chargeable to income tax at the individual’s marginal rate.

In the meantime:

• HMRC commented in April this year that amending legislation was likely to be brought in before TTFACs would be issued and later be found to be wrong.  Of course, the General Election has intervened, resulting in further delay to fixing the legislative gremlins. 
• Administrators who discover that they have inadvertently made an unauthorised payment in such circumstances, and before the legislation is amended, should take this up with HMRC. 

Annuity providers: unable to give a TTFAC? 

At present, an individual who has a pension in payment from an annuity provider cannot apply to that provider for a TTFAC (because a TTFAC may only be issued by a “registered pension scheme”, which excludes annuity providers of pensions in payment).

Future legislation is expected to:

• Allow annuity providers to give TTFACs (including for individuals drawing benefits).

In the meantime:

• An individual who has a pension in payment from an annuity provider, and who wishes to rely on a TTFAC when crystallising benefits from another scheme, will need to apply to that other scheme for a TTFAC (and supply details of the benefits crystallised under the annuity).

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Authored by the Pension Team.