Pension holders, beware! A new regulation in the UK’s pension system may lead to some unexpected tax bills for those not paying close attention. Starting April 6, 2024, a significant change will take effect concerning how much tax-free money you can withdraw from your pension. Wealthy savers, in particular, need to gear up for this change as it primarily affects those with substantial pension pots.
The Introduction of a Lump Sum Cap
Previously, the lifetime allowance (LTA) limited the amount you could accumulate in a pension without incurring taxes to £1.073 million. This cap has now been abolished, a change initially celebrated by those with larger pensions. However, the reform comes with a twist: a new cap on tax-free lump sums. This new cap, set at £268,275, replaces the old system where you could take up to 25% of your LTA as a tax-free lump sum.
Why Keeping Records is Crucial
According to Alasdair Mayes, a partner at Lane Clark & Peacock (LCP), “In the past, there was no specific lifetime limit on tax-free cash, so there has been no need to keep records as to how much you have taken in total.” But with the new rules, the burden is now on pension holders to keep track of their withdrawals. This is especially important because if you don’t have records, HM Revenue & Customs (HMRC) will make an estimate. For some, this estimate could unfairly reduce the amount of tax-free cash they are entitled to.
The Issue with Estimates
The default HMRC approach assumes that savers have taken 25% of their pensions as a tax-free lump sum every time benefits were crystallised before the rule change. However, this isn’t always the case. For example, individuals in defined benefit schemes may have preferred regular income over a lump sum, or older defined contribution schemes might have offered beneficial annuity rates, leading members to utilise their entire fund for a better income.
Transitional Tax-Free Amount Certificate
To counter potential unfair estimates, HMRC is offering a Transitional Tax-Free Amount Certificate (TTFAC). This certificate could allow savers who have previously taken less than the maximum allowed tax-free cash to claim 25% tax-free withdrawals on future pensions. Sir Steve Webb, also a partner at LCP, emphasises that exploring the option of a TTFAC is “well worth” for savers to avoid missing out on tax-free opportunities.
Guidance for New Pensioners
For those about to draw their pension for the first time, the process should be relatively straightforward. When you take some tax-free cash from your pension, your scheme or provider will document how much of your lump sum allowance (LSA) you’ve utilised. It’s crucial to keep this information, as it must be reported if you withdraw from additional pensions later.
The Golden Rule – Keep Everything
Sir Steve Webb’s advice rings clear for all savers: “The lifetime allowance may have gone away, but the need to keep records of all of your pensions, including ones you’ve taken in the past, has not.” Keeping thorough records and documentation could save you from unnecessary taxation and ensure you maximise your pension benefits under the new system. Remember, in the realm of pensions, paperwork is your best ally.