Key Points

  • New rules came into force on 06 April 2024 which limit how much tax-free cash can be taken from a pension.
  • If you have a lot of pension benefits and you took any pension benefits prior to 06 April 2024, you could get an increased allowance.
  • You must apply for this increase before you take any further pension benefits.
  • Book a free initial meeting with one of our advisers to see if you are affected by this change.

The New Allowances

Two new pension allowances were introduced on 06 April 2024:

  • The Lump Sum and Death Benefits Allowance (“LSDBA“), which caps how much can be paid out on death as a tax-free lump sum. It is £1,073,100.
  • The Lump Sum Allowance (“LSA“), which caps how much can be taken tax-free from your pension benefits. It is £268,275 (note this is one-quarter, or 25%, of the LSDBA – the relevance of which will be seen later).

Lump sums taken from pension benefits after 06 April 2024, such as tax-free cash, reduce both allowances.

Some people may have a larger LSA and LSDBA than the amounts quoted above. This applies if the pension member has Primary Protection, Enhanced Protection, or one of the Fixed Protections – which are beyond the scope of this post.

Pension benefits prior to the LSA and LSDBA

If you took any pension benefits prior to 06 April 2024, you will not have a full LSA or LSDBA.

Prior to 06 April 2024, the “Lifetime Allowance” was in force. Any pension benefits taken before this date used up a percentage of your Lifetime Allowance. The tests for what used up the Lifetime Allowance were broader than the new tests against the LSA and LSDBA.

Your remaining LSA and LSDBA are calculated based on the remaining percentage of your Lifetime Allowance.

However, this calculation is complicated as it depends on how your pension benefits were taken.

Tax charge on breaches

If the LSA or LSDBA is breached, there is an income tax charge.

The excess amount over the LSA or LSDBA is added to the recipient’s other income (either the pension plan member or the death beneficiary, as relevant).

The tax charge is then 0%, 20%, 40%, or 45% (or a combination of all four), depending on the excess amount and the recipient’s other taxable income.

It is worth noting this is all very different to what happened with a Lifetime Allowance breach, where the tax charge was either 25% plus income tax or 55%, depending on how the excess over the Lifetime Allowance was taken.

So what does this have to do with tax-free lump sums

First, I must stress this post only covers personal pension plans – it does not relate to defined benefits pension plans. While defined benefits plans are affected by the LSA and LSDBA, this cannot be addressed by our company and it is beyond the scope of this post.

There are specific types of pension benefit which are tested against the LSA. As you might guess, the tests take place when a tax-free lump sum benefit is taken from a pension plan.

This normally comes in the form of a tax-free lump sum (for example, taking 25% of your pension plan value as a tax-free lump sum).

More rarely, it also includes the tax-free portion of an “Uncrystallised Funds Pension Lump Sum” or “UFPLS” (which is beyond the scope of this post).

You could be entitled to get extra tax-free lump sums if you:

  • Have large pension benefits and
  • You have have taken pension benefits prior to 06 April 2024

But you must take action and you must take this action before taking any more lump sums. This is explained below.

For the mathematically minded

As noted above, the LSA is one-quarter, or 25%, of the LSDBA. The LSA assumes one-quarter is the default tax-free entitlement.

However, for those who took pension benefits before 06 April 2024, the remaining LSA is based on how much Lifetime Allowance was used beforehand. And the Lifetime Allowance tests did not always work on a one-quarter tax-free basis.

For example, if someone who had never previously taken any pension benefits was offered a defined benefits/scheme pension income of £40,000 per year with no tax-free lump sum, the Lifetime Allowance test was:

£40,000 x 20 = £800,000

With a standard Lifetime Allowance of £1,073,100, the percentage used was:

£800,000 / £1,073,100 = 74.55% used and 25.45% remaining

So, this person has not taken any tax-free lump sums from their pension benefits. You might assume they would have a full LSA available of £268,275.

Unfortunately, this is not the case.

This is because the LSA assumes one-quarter, or 25%, of the Lifetime Allowance percentage used was in respect of a tax-free lump sum – regardless of what was actually taken tax-free.

So this person’s LSA would be:

£268,275 (standard LSA) – 25% x £1,073,100 standard LSDBA x 74.55% used = £68,275

If this person did not have any other pension benefits, this could be a non-issue.

But if this person has, say, a £500,000 personal pension plan, it is an issue.

This is because with a full LSA, they would be able to take one-quarter of the personal pension plan (£125,000) as a tax-free lump sum without breaching the LSA. They would even have some LSA left over.

However, with their reduced LSA, they would only be able to take £68,275 of the personal pension plan as a tax-free lump sum before reaching the LSA.

More acronyms

In this scenario, the pension plan member could apply for a Transitional Tax-Free Amount Certificate or TTFAC.

This would allow them to take more of their personal pension plan as a tax-free lump sum.

But they can only apply for such a certificate if they have not taken any tax-free lump sums on or after 06 April 2024.

Even taking just £1 of tax-free lump sum would stop an application for a TTFAC.

What can you do now

As you can probably appreciate, this issue is complex. So you should seek regulated financial advice to assess whether this issue is relevant to your circumstances and, if so, what action should be taken (if any).

If your adviser believes you can benefit from applying for a TTFAC, they will complete the application and help you assess the best way in which to take your tax-free cash entitlement form your personal pension plan(s).

To book a free initial meeting with one of our advisers, please call 01642 477758 or visit our Contact page.