HMRC has confirmed that the draft legislative clauses for the new tax regime are not intended to extend pension freedoms to defined benefit arrangements.
HMRC has issued Newsletter 152, which offers an overview of the draft legislative clauses (published 18 July 2023 – legislation day) for the pensions tax framework from 6 April 2024.
These clauses include changes to the definition of a pension commencement lump sum (PCLS), which significantly relax the conditions attached to paying benefits as lump sums (albeit making them taxable to the extent that (broadly) they are more than available under the current regime). While the 2015 pension freedoms grant defined contribution (DC) arrangements the flexibility to pay benefits as lump sums, the draft legislation would extend similar freedoms (at least at retirement) to defined benefit (DB) arrangements. HMRC has now confirmed in its Newsletter that:
"it is not the government's intention to significantly expand pension freedoms".
This suggests very strongly that there will be changes to the PCLS clauses to restrict the taxable lump sum that can be taken from DB arrangements.
The Newsletter invites responses to the consultation, specifically in the following areas:
- Crystallised lump sum death benefits
- Excess pension commencement lump sums, designed to accommodate the absence of the lifetime allowance excess lump sum
- Small lump sums
- Winding up lump sums
- Trivial commutation lump sum.
These are the areas of most contention within the draft legislation – see our e-alert for details.
As noted in our e-alert, there was also another headline-grabbing announcement in the policy paper: where a beneficiary nominates uncrystallised funds for drawdown or a dependants' annuity, amounts withdrawn/payable will be taxable. The Newsletter confirms that clauses to implement this are not included in the draft legislation, but still invites comments on this area.
In relation to the PCLS, it appears that, from 6 April 2024, a PCLS will be an authorised lump sum provided that the following existing conditions are met:
1. The member becomes entitled to it in connection with becoming entitled to a relevant pension (income withdrawal, lifetime annuity, scheme pension)
2. It is paid within the period beginning six months before, and ending one year after, the day on which the member becomes entitled to the relevant pension
3. It is paid when the member has reached normal minimum pension age (or the ill-health condition is satisfied), and
4. It is not an excluded lump sum (no lump sum is available where a collective money purchase scheme winds up and pensions in payment are converted to a drawdown fund).
These are current requirements, with which schemes will generally be familiar. However, another existing requirement is removed. No longer will a lump sum constitute a PCLS only if it is no greater than the lower of:
- 25% of the member's available lifetime allowance, and
- 25% of the benefit value.
This means that a lump sum of any value could constitute a PCLS (provided that conditions 1 – 4 above are met).
As ever, it's not quite that straightforward. The taxation of a PCLS is changing from 6 April 2024, with the PCLS tax-free only to the extent that, usually, it is no greater than the lower of:
- A member's available individual lump sum allowance (ILSA) (normally a maximum of £268,275), and
- 25% of the benefit value.
Any excess will be taxed at the member's marginal rate of income tax.
This effectively brings back in the previous determination of a maximum amount but does so only in relation to how much can be paid tax-free. It does not restrain the lump sum amount that can actually be paid.
It was always the case that a replacement authorised benefit would be needed for the Lifetime Allowance Excess Lump Sum (LAELS). This falls away without the concept of an LTA and schemes need the ability to pay a PCLS where the lump sum benefit under the scheme rules exceeds the member's available ILSA. The draft legislation delivers this, but also far more – though only if scheme rules permitted a higher lump sum. It now appears that this will change, although the timescale for sight of any revised drafting is unclear. If schemes have to wait until the Finance Bill is presented to Parliament, that would be too late for implementation of a new regime from 6 April 2024.
This article was first published on WTW.
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