When Chancellor Jeremy Hunt stood up to present March 2023 budget, it was widely expected that one of the announcements would be a lifting of the Lifetime Allowance (LTA) for pensions, but what virtually nobody predicted was that the LTA would be abolished altogether.
As with any sizable change to pension schemes, the move was likely to trigger consequences and complications for a broad demographic of individuals, and whilst some would benefit, there would be those for whom the results would be less positive. In this article we’ll look at the substance of the changes and how they might impact on cases of divorce and inheritance, two life-events in which pensions, and particularly larger pension pots, often have a role to play.
Lifetime Allowance abolition
In simple terms, the LTA was the maximum amount that could be drawn from a workplace or personal pension without any tax being paid. Prior to the March 2023, LTA was set at £1,073,100, and if an individual’s pension pot or collective pension pots were worth more than this, then they would generally face an extra tax charge.
The rationale for the change offered by the government was that many Doctors were opting to retire and take their pension before breaching the £1,073,100 figure in order to avoid being hit with a tax bill. The details of the budget announcement were that the LTA charge would be removed from 6th April 2023, with a future Finance Bill abolishing the charge altogether from the 2024/25 tax year onward.
Divorce and Pensions
How pensions are generally dealt with following a divorce is often a contentious issue in instances where one partner has stayed at home to raise a family while the other has worked and built up a substantial pension.
Pensions post-divorce are usually dealt with in one of three ways as part of any settlement:
- Pension sharing: A pension sharing order is a formal court order which transfers all or some of the money from the pension of one spouse to the name of the other spouse, replicating what would have happened if the latter had paid into the pension fund on their own behalf. Once this has happened the spouse will be able to draw down from the pension in line with the rules of the scheme.
- Pension attachment: This involves one of the spouses paying a percentage of their pension income to the other spouse. In this case, the latter spouse will only start to receive their share of the pension after their former spouse has started to take it.
- Pension offsetting: This arrangement involves the amount of money which is in a pension pot or pots being taken into account when the settlement is being negotiated. This generally involves the spouse who isn’t in receipt of the pension accepting a greater share of other assets – such as the family home – in lieu of the amount in the pension.
While the scrapping of the LTA doesn’t alter the ways in which a pension is likely to be divided following a divorce, it does complicate matters due to the fact that some pension pots, now that there is no tax disincentive to adding to them, are likely to exceed – sometimes to a large degree –the old £1.7 million ceiling.
In addition, there is now no charge to be levied when pensions are drawn down or taken as a lump sum from pots which breach that ceiling. This is particularly likely to muddy the negotiations for those divorces which were ongoing when the change was announced, or in which an agreement may have been reached in principle but not formally set in stone.
The net value of any fund worth more than £1.7 million has now increased, and this rise will need to be taken into account if a couple have agreed to a pension sharing order, with particular reference to the percentage of the fund to be transferred to the name of the person without the pension.
The fact that the amount of tax to be paid on receipt of any funds from a pension – either as a lump sum or an income – has now been reduced means that the non-pension holder in a divorce settlement could find themselves out of pocket if the pension sharing arrangement isn’t altered to take account of the changed circumstances.
The same issues will apply in those cases in which one spouse has agreed to take a greater proportion of other assets in order to balance the pension pot being fully retained by the other spouse. In cases such as these, the increased value of the pension pot will need to be recalculated and applied to the details of any agreement.
One other complicating factor is that, previously, pension sharing may have presented an appealing option post-divorce due to the fact that it would eliminate or reduce the tax to be paid on the two separate pensions thanks to the application of the LTA. The removal of this advantage means that the spouse with the pension pot may, in future, be less easily persuaded to share it.
In the years to come, assuming the LTA isn’t re-introduced by any future government, a pension pot could be one of the most valuable assets to be dealt with by a divorcing couple, and this is likely to make pension offsetting less of a feature of divorce settlements, inasmuch as not many assets will be worth enough to counterbalance a pension worth in excess of £1.7 million.
Inheritance Tax
While the abolition of the LTA may complicate divorce settlements going forward, it could also impact on estate planning. In simple terms, individuals or families with sufficient means may now opt to pay much more into their pension pots, creating funds that won’t be liable for income tax until they are benefitted from and which are sheltered from the impact of Inheritance Tax (IHT).
The IHT position with regard to pension pots differs depending upon a range of factors. If the pension is a money purchase scheme, which covers the bulk of private company pensions, then it will usually not be counted as part of your estate used to calculate IHT when you die.
An ‘expression of wishes’ form filled in with your pension providers will name the beneficiary or beneficiaries you wish to receive your pension after you die, and the percentage left to each in the case of multiple beneficiaries. The amount each beneficiary receives and the tax due will vary depending on the circumstances.
If you die before turning 75 and haven’t already taken any of the pension, the recipient won’t usually be liable to pay any tax if they receive it within two years of your death. They will also be entitled to choose between a lump sum, drawdown or annuity.
If you have already started to take the pension, then the manner in which you have done so will determine the tax position. If you withdrew a lump sum, some of which is still left in your bank account, the money will be treated as part of your estate subject to IHT (if applicable). If you chose a drawdown, on the other hand, your beneficiaries will be able to access whatever is left in the pension pot without having to pay tax, whether they opt for drawdown payments, take out a lump sum or buy an annuity.
If you’ve already started taking income from an annuity before dying, this will generally stop upon death and can’t be passed on. If you die after the age of 75, on the other hand, the beneficiary or beneficiaries will pay tax at the rate which normally applies to their income – 20%, 40% or 45% – on anything they take from the pension, and this is the same whether you have started taking the pension or not.
In general terms, then, a pension pot can be passed on free from IHT or any other tax if you die before the age of 75 and subject only to the beneficiaries’ personal tax rate if you die after the age of 75.
The abolition of the LTA is likely to mean pension pots play a larger role than ever in estate planning in the future, as they offer a potentially highly tax-efficient means of saving and passing money on.
Should you require any support with regard to the management of your pension or wealth, specifically with regard to IHT or divorce, please do not hesitate to contact our expert team for an impartial, confidential consultation.
