Pensions changes for 2024/25 onwards – how they work

Limits on pension tax relief and changes to inheritance tax

For higher earners, the ability to contribute into pensions was historically curtailed by two restrictions. The Annual Allowance (AA) restricts the amount a person can pay into a pension during a particular year. The Lifetime Allowance (LTA) seeks to cap the size of the fund that accrues during your lifetime.  

These limits are perceived to cause practical problems. Whereas private sector workers caught within the restrictions can control their pension contributions, public sector workers usually cannot, as their employers will continue to contribute based on their earnings. In practice, the only way high earning public sector workers (such as senior NHS clinicians) are able to limit their exposure to AA and LTA charges is by restricting their earnings by choosing to work less, or retire (if only temporarily in the case of some healthcare professionals). 

From 6 April 2023 the LTA charge was abolished and the limits for the AA were increased to “help remove incentives for doctors to work reduced hours or retire early due to pension tax concerns.” However, the changes from 6 April 2023 apply to all pensions meaning individuals with large pension pots across all sectors of the economy can benefit from them. 

From 6 April 2024 the underlying framework with regards the LTA was removed and substantial new legislation was introduced, broadly dealing with tax arising on and after retirement and introducing new terminology. 

Budget 2024 brought more drastic changes for pensions with the effective abolition of the IHT exemption from 6 April 2027. This is perhaps not surprising, given the prevalence of defined contribution schemes (which can be inherited), and the abolition of the lifetime allowance charge in 2023.

The Autumn Budget 2024 announced the effective abolition of the IHT exemption from 6 April 2027. The aim is to prevent pensions from being used as a tool for avoiding IHT. 

However, if the deceased dies on or after their 75th birthday, withdrawals from the pension by beneficiaries is subject to income tax at their marginal rate, meaning that funds could be subject to overall effective taxes of up to 67% before reaching the beneficiary. The published Budget documents do not mention this fact, but a consultation was announced during which it will almost certainly be raised - watch this space.  

Where IHT is payable, it is paid by the pension fund to prevent withdrawals being required (and possibly taxed) to pay the IHT.  


Where pension contributions for a tax year exceed the AA, the excess is subject to charge at the person’s marginal rate of income tax. The available AA is also tapered by £1 for each £2 adjusted income exceeds a defined limit. 

From 6 April 2023, the AA increased from £40,000 to £60,000. The adjusted income limit also increased from £240,000 to £260,000 and, where tapering applies to reduce the AA for an individual, the minimum tapered AA is now £10,000 (up from £4,000). Therefore, from 6 April 2023, the maximum possible reduction to the AA is £50,000, i.e. anyone with adjusted income of £360,000 or more will have their AA tapered to the £10,000 minimum. 

Where a public sector worker is a member of both a closed and an open pension scheme, they will be linked, and the combined pension income will be calculated as if it were a single scheme. This enables the offset of negative real growth in legacy public sector schemes when calculating the AA. 

As before, any unused AA can be carried forward for three years and utilised if the AA in a subsequent year is exceeded. For example, if you have unused AAs from any of the past three tax years these can be used in addition to your current year AA limit enabling you to increase your maximum tax-relieved pension contributions for the current year. 

        

For 2022/23 and earlier years, the LTA (£1.073m for 2022/23) was the maximum savings an individual could hold in a pension fund without facing penal tax charges when taking pension benefits. On a ‘benefit crystallising event’ (‘BCE’) (e.g. first accessing pension income or 75th birthday), pension funds were tested and, if their value exceeds the LTA, the excess was subject to a tax charge. 

Up to £268,250 (25% of the LTA) could be taken as a tax-free lump sum when benefits were first drawn. The balance of the LTA could then be used to acquire an annuity, or be drawn down as needed, in both cases subject to PAYE. 

For any excess pension fund above the LTA, for 2022/23 and earlier years, there was a LTA charge on a BCE. The amount of charge was dependant on how the excess amount was accessed. When the excess was taken as a lump sum, tax was charged at a rate of 55%. Where the excess remains in the pension fund an automatic 25% charge applied - the lower amount reflecting the fact that future withdrawal of those funds would have been subject to PAYE. 

An LTA charge could also arise when benefits were not accessed, e.g. on 75th birthday or death before 75th birthday – usually being a 25% LTA charge on the basis that no lump sum is taken. 

Between 6 April 2023 and 5 April 2024, the LTA charge simply no longer applied when a BCE arose.  Rather than being subject to an LTA charge on a BCE, the excess pension over the LTA was subject to income tax on withdrawal at the individual’s marginal rate of tax, collected through PAYE. 

Importantly, the LTA continued to exist within the legislative framework, and it continued to apply for the purpose of capping the 25% tax-free lump sum.  

The real tax reduction arising from the abolition of the LTA is for those who do not choose to withdraw the excess immediately as there will be no 25% charge. Drawing down on larger funds will be subject to income tax, but that was previously the case too. 

From 6 April 2024 the LTA was effectively renamed the lump sum and death benefit allowance (‘LSDBA’), with the sole purpose of now restricting the available 25% tax free lump sum. The lump sum allowance (‘LSA’) is a person’s maximum tax-free lump sum available to them, i.e., 25% of the LSDBA, generally being £268,275. From 2024/25 the annual statements / forms P60 issued by the pension administrator must now also show the amount of LSA and LSBDA used to date. 

From 6 April 2024, the LSBDA remains available for lump sum death benefits where the deceased had not crystallised the pension before their death, meaning that where the deceased has not previously claimed their 25% tax free lump sum, it might be available to the beneficiary. 

Historically, on each occasion that the LTA has been reduced, an individual meeting certain criteria has been able to claim protection such that the retain an LTA at the higher level. Protected LTAs/LSBDAs continue to apply for the purposes of determining the maximum 25% tax free lump sum available.  

Individuals who have protected their LTA in past years may have been restricted from adding new funds to their pot as a condition of that protection. From 6 April 2023, individuals who held protection for their pension before 15 March 2023 will be able to accrue new pension benefits, join new arrangements or transfer their savings without losing their entitlement to their higher protected LTA/LSBDA.  


When a person first accesses a pension of any kind to draw income, their available annual allowance for all subsequent years, for the purpose of defined contribution schemes, is automatically tapered to the MPAA, regardless of their income level. The MPAA was be increased from 6 April 2023 from £4,000 to £10,000. Therefore, individuals who have already started to take pension income but have resumed or continued work, can again make modest top ups to their pension funds from 2023/24 onwards. 


Planning ahead

The 2023 and 2024 changes were welcomed by higher earners looking to contribute more into their pensions and individuals who already had pension funds valued above the £1.073m LTA – particularly those who do not have a higher protected LTA.  

Therefore, in light of the Budget 2024 changes, for many individuals with large pension pots it may now be appropriate to revisit their established plans and update their Wills and letters of wishes (and consider using trusts) to ensure their families get the full benefit of any pension funds remaining at their death.  

Leaving your pension fund to your children could in future trigger a combined tax charge of up to 67% so there may well be more tax-efficient ways to pass on your wealth: for example, leaving your pension fund solely to your spouse will still be tax-free. 

So, as well as revisiting Wills in relation to their pension, anyone with a significant pension fund would be wise to also consider lifetime gifting as part of the mix in passing on wealth.

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