Pension policy in the UK has undergone significant shifts recently, reflecting a change in government and differing priorities. The first Labour budget in 14 years expanded taxation on pensions, moving away from the Conservative approach of encouraging pension savings and longer workforce participation.
Finance Act 2024: Encouraging Pension Savings
In their last year of government, the Conservatives made significant legislative changes affecting pensions. Their aim was to encourage pension saving while retaining limits on tax-free pension benefits through measures including the removal of the Lifetime Allowance (LTA). The LTA, previously capped at £1,073,100, was seen as a disincentive for high earners to continue working. Its removal aimed to encourage longer workforce participation, addressing labour shortages in key sectors such as the NHS.
Despite the removal of the LTA, tax-free cash withdrawal limits remain, facilitated by three new allowances:
- Lump Sum Allowance (LSA): £268,275 (25% of £1,073,100). This caps the Pension Commencement Lump Sum (PCLS) and/or the tax-free portion of an uncrystallised funds pension lump sum (UFPLS).
- Lump Sum and Death Benefit Allowance (LSDBA): £1,073,100, the maximum amount that can be taken from pension arrangements tax-free over life and at death.
- Overseas Transfer Allowance (OTA): £1,073,100, matching the LSDBA.
Before April 2024, a transfer to a QROPS was tested against the LTA as a benefit crystallisation event. With no prior crystallisation event, it was possible to transfer £1,073,100 to a QROPS tax-free, with any excess subject to a 25% LTA charge. The removal of the LTA could have led to pensions of unlimited value transferring tax-free to a QROPS. To prevent this, all transfers to overseas pensions are now tested against the OTA, with any excess subject to a 25% overseas transfer charge.
Existing LTA protections can be applied to the LSA and LSDBA calculations.
Taxation of Death Benefits
The taxation of death benefits post-age 75 remains the same, taxed at the beneficiary’s marginal rate. For deaths occurring before age 75, changes include:
- Uncrystallised Funds – Lump Sum Death Benefit: Excess over LTA taxed at 55% (old regime) vs. excess over LSDBA taxed at beneficiaries’ marginal rate (new regime).
- Uncrystallised Funds – Dependent/Nominee Drawdown or Annuity: No tax on crystallisation event, income tax-free.
Transitional Rules
For individuals with crystallised benefits pre-April 2024, transitional rules ensure they are not worse off regarding tax-free cash.
The Impact on Pension Savers in the UK and Abroad
Removing the lifetime allowance encouraged high earners to continue working and saving. However, introducing IHT on unused pensions changes this dynamic, discouraging wealth retention in pensions for succession planning. Instead, the government aims to ensure tax reliefs support retirement income savings.
High-value UK pension holders and expats must reassess financial plans. The removal of IHT incentives may lead to earlier pension withdrawals. UK expats in low-tax countries might fully access pensions to avoid UK tax liabilities and use alternative, tax-efficient products, such as offshore bonds for future withdrawals. This shift opens new planning opportunities aligned with the evolving pension landscape.