The New UK Lump Sum Allowances: What You Need To Know

25 September, 2024

The new 2024/25 UK tax year began on 6 April, heralding the abolition of the UK’s Lifetime Allowance (LTA) and the introduction of new UK lump sum allowances. These changes marked a significant milestone in UK pensions, dismantling a regime that had been introduced in 2006 by then Chancellor Gordon Brown.

Given the complexities that the LTA created for clients with pension pots above £1,000,000, advisors like Florin Pensions widely welcomed its abolition. However, the new lump sum allowance legislation is still not without some complication (some of which will require further amendments to iron out).

This article aims to provide a high-level overview of the new UK lump sum allowances and how they could impact your future retirement planning.

What are the new lump sum allowances?

Three new UK lump sum allowances have been introduced.

Putting to one side an allowance that only applies when a UK pension is transferred outside of the UK into a QROPS (Qualifying Recognised Overseas Pension Scheme), the two key lump sum allowances are:

Lump Sum Allowance (LSA)

• at any time from age 55 (rising to 57 from April 2028) you can usually take up to 25% of your pension as a UK tax free lump sum.
• the LSA restricts the maximum cumulative UK tax-free lump sums you can draw from all your UK pension pots to £268,275, unless you have a higher protected amount (see below).

Lump Sum and Death Benefit Allowance (LSDBA)

• is the fixed cumulative limit of lump sum payments that can be paid to or in respect of your UK pensions tax-free in life and death.
• the fixed limit is £1,073,10 unless you have a higher protected amount (see below).

There is no provision for the LSA or LSDBA limits to be increased in future tax years in line with inflation.

When do the LSA and LSBA apply?

The LSA and LSDBA do not apply to pension payments taken under Flexi-Access Drawdown. The LSA and LSDBA only apply:

• when you start to draw from a UK pension; and
• only if drawing as a lump sum payment.

There are different types of UK pension lump sum payments depending upon the type of UK pension you have and how you have chosen to draw from a pension. However, examples include taking a pension commencement lump sum (PCLS) or drawing from a defined contribution pension by taking one or more uncrystallized fund pension lump sums (UFPLS).

Any lump sum payment that exceeds the LSA is taxable at your applicable marginal rate of UK tax. Under the LSDBA when a death benefit is paid as a lump sum, it will only be UK tax-free if when you die you have remaining LSDBA. Any excess would be taxable at your beneficiary’s marginal rate of UK income tax. This applies regardless of the age when you die (e.g. pre or post age 75).

What do these changes mean for my UK pension?

If you haven’t drawn from your UK pension yet, and the total value of all your UK pensions is unlikely to exceed £1,073,100, then the amount of UK tax-free benefits you or your beneficiaries will receive should essentially be the same as before.

What is different is the way your UK pension provider(s) will describe your limits. In the past, your UK provider would confirm how much UK LTA you had. Instead, your pension provider will now reference the amount of lump sum allowances that have been used. If you have more than one UK pension you will also need to provide information to your UK pension providers on any UK tax-free lump sums you have already taken.

I have already used up some or all my old UK LTA, what happens now?

There are transitional calculations if you have taken benefits before April 2024 to determine how that will translate into the new lump sum allowances. This means any UK tax-free lump sums you took under the old LTA regime, or before April 2006, will count towards your LSA and LSDBA.

If you had used your full entitlement to the LTA prior to April 2024, you will have no available LSA or LSDBA. If you had the option to take a UK tax-free lump sum before 6 April 2024, but chose not to, you might find your LSA has still been reduced as if you had. For example, if you decided to take less than 25% of your PCLS before your defined benefit pension started.

If this is the case, you can apply for a transitional tax-free amount certificate from your UK pension provider. This confirms the UK tax-free amount actually taken and can result in your remaining lump sum allowance increasing.

You can only apply for a transitional certificate before you take your first UK tax-free lump sum payment after 6 April 2024 (when the new regime entered into force).

The need for a transitional tax-free certificate will, in our view, not be that common and obtaining a certificate could in some circumstances be unfavorable for some. Before applying for a certificate, careful consideration should be given to what the benefits would be because once it is obtained, it cannot be surrendered. Consequently, prior to applying for a transitional tax-free certificate, we recommend speaking with a financial advisor.

What is a “higher protected amount” – can I increase my LSA/LSDBA limit?

If you meet the eligibility criteria, you have until 5 April 2025 to apply to the UK’s HMRC for Fixed Protection and/or Individual Protection 2016 in order to receive a higher LSA and LSDBA limit – a “protected amount”. For Fixed Protection 2016, this would provide an LSA of £312,500 and an LSDBA of £1,250,000.