The UK pension system underwent a significant change in April 2024, with the abolition of the Pension Lifetime Allowance (LTA). Previously, individuals faced tax charges if their pension savings exceeded the LTA, which was set at £1,073,100. This limit has now been replaced by three new pension allowances that provide more flexibility for retirement planning. In this post, we will explore the details of these new rules and how they impact your pension savings and retirement strategy.
What Was the Pension Lifetime Allowance?
Until April 2024, the Pension Lifetime Allowance was a cap on how much you could accumulate in your pension pots without facing a tax charge. If the value of your pension savings exceeded this threshold, you were taxed on the excess, with rates ranging from 25% to 55%, depending on how you accessed your pension benefits.
As of April 2024, the LTA has been abolished, and in its place are three new allowances aimed at offering greater flexibility in pension planning.
The Three New Pension Limits
The new pension rules introduced on April 6, 2024, include three main allowances:
1. Tax-Free Lump Sum Allowance
The tax-free lump sum allowance limits the amount you can take as a tax-free cash lump sum from your pension. This allowance is fixed at £268,275, which is 25% of the previous LTA of £1,073,100. However, individuals who had a ‘protected right’ to a higher amount as of April 5, 2023, can continue to access a higher tax-free lump sum.
For example, if you take £100,000 in tax-free cash from your pension, the remaining tax-free lump sum allowance would be reduced as follows:
- £268,275 – £100,000 = £168,275 remaining.
If you have already used part of your pension allowance, such as withdrawing benefits between April 6, 2006, and April 5, 2024, your remaining lump sum allowance will be reduced based on the percentage of the LTA you used.
For instance, if you had used 70% of your LTA before 2024, the calculation would be:
- £1,073,100 × 70% = £751,170
- £751,170 × 25% = £187,792 used
- £268,275 – £187,792 = £80,483 remaining
2. Lump Sum and Death Benefit Allowance
The Lump Sum and Death Benefit Allowance (LSDBA) applies to lump sums paid on death before the age of 75. The standard LSDBA is £1,073,100. If you take £100,000 in tax-free cash, both your lump sum allowance and LSDBA will be reduced:
- £268,275 – £100,000 = £168,275 remaining lump sum allowance
- £1,073,100 – £100,000 = £973,100 remaining death benefit allowance.
If you have already used some or all of your LTA, the same calculation applies to reduce the LSDBA based on the percentage of your LTA used. For example, if you’ve used 70% of your LTA before April 2024, the remaining LSDBA would be:
- £1,073,100 – £187,792 = £885,308 remaining.
If you die before 75, your beneficiaries can receive your pension benefits tax-free, but if you pass away after age 75, they will be taxed on the inheritance.
3. Overseas Transfer Allowance
The Overseas Transfer Allowance allows you to transfer your pension benefits to a Qualifying Recognised Overseas Pension Scheme (QROPS) without incurring tax charges, up to a limit of £1,073,100. If you transfer a pension worth £500,000 to a QROPS, the remaining overseas transfer allowance would be:
- £1,073,100 – £500,000 = £573,100 remaining.
If you have already used some of your LTA before April 6, 2024, the overseas transfer allowance will be reduced by the same percentage. For example, if you used 70% of your LTA before the new rules, the overseas transfer allowance would be reduced by the same 70%, meaning only 30% would remain.
What Happens if You Exceed the New Pension Limits?
Any pension benefits that exceed the new allowances are added to your taxable income and taxed at your applicable rate. For instance, if you receive a lump sum of £25,000 that exceeds your lump sum allowance and you earn £150,000 a year, the excess would be taxed at the higher tax rate, potentially at 45%.
Pension Lifetime Allowance Protection
If you had a higher tax-free cash amount before April 2024, you may have protection for your pension lifetime allowance. This protection can help you retain a higher tax-free cash amount than the new limits.
If you had a protected amount, it will be converted into the new lump sum and death benefit allowances. A transitional tax-free amount certificate will indicate the tax-free lump sum benefits you took before April 6, 2024, and it will help ensure you can use the correct allowances going forward.
Should You Apply for a Transitional Tax-Free Amount Certificate?
In some cases, applying for a transitional certificate can benefit you, especially if you took less than the standard 25% tax-free lump sum from your pension before April 2024. If you’ve used the full LTA, applying for a certificate may reinstate some of your lump sum and death benefit allowances.
Conclusion
The removal of the Pension Lifetime Allowance and the introduction of new pension limits and allowances offers more flexibility but requires careful planning. It’s essential to understand how these new rules affect your pension, particularly regarding lump sums, death benefits, and overseas transfers. If you’ve already used part of your pension allowance, reviewing your options and speaking to a financial advisor could help ensure you make the most of the new system while minimizing tax liabilities.
