Soon the pensions tax rules change; out goes the lifetime allowance, and in comes two new allowances measuring how much can be taken as tax-free cash lump sums.
If you have clients with pension funds around the £1,073,100 mark, then it is worth taking some time to understand the new rules and learn the full impact of them on your clients’ pension savings.
This article gives a recap of the rules for those who have already started taking pension benefits in the current regime, as well as explaining what the transitional tax-free amount certificate is, and when it could be useful for clients to boost their allowances.
The new allowances
In the new pensions regime people can take as much taxable pension income as they want without it being tested or subject to an additional tax charge. However, there are two new limits on the amount of tax-free lump sums they, and their families, can take:
- The lump sum allowance (LSA) – usually set as £268,275 – measures tax-free lump sums taken in life as pension commencement lump sums and the tax-free part of an uncrystallised funds pension lump sum.
- The lump sum and death benefit allowance (LSDBA) – usually set as £1,073,100 – measures the tax-free lump sums used by the LSA, any benefits paid out as a serious ill-health lump sum (SIHLS), and any tax-free lump sums paid out on death to beneficiaries.
These amounts may be increased if the pension saver has LTA protection.
From April 6 2024, taking these lump sums will be tested against these allowances at a relevant benefit crystallisation event.
The transitional rules
If the pension saver has already taken benefits in the current regime, then the allowances will be reduced the next time benefits are tested after April 6 2024.
The LSA will be reduced by 25 per cent of the LTA used. For example, if 40 per cent of the LTA has been used, the LSA will be reduced by 10 per cent (25 per cent of 40 per cent) of £1,073,100, so reduces from £268,275 to £160,965.
The LSDBA will be reduced by:
- 100 per cent LTA used by any SIHLS paid.
- 100 per cent LTA used to pay a lump sum death benefit in relation to members who died before age 75.
- 25 per cent of LTA used otherwise.
In most cases, where no SIHLS or death benefit lump sums have already been paid, the reduction for the LSDBA will be the same as for the LSA. In the example above, the LSDBA would also be reduced by £107,310 to leave £965,790 available.
If 100 per cent of the LTA was used before April 2024, then the LSA and LSDBA will be nil.
When paying lump sums to beneficiaries following death, it is important to remember any lump sum death benefits paid from drawdown funds set up before April 6 2024 will not be tested against the LSDBA.
What is the transitional tax-free amount certificate?
The transitional calculations assume, for simplicity, that everyone took 25 per cent of the LTA they previously used as tax-free cash (except for SIHLS and death benefit lump sums). However, this may not be the case.
For example, some defined benefit scheme members may have received less cash because of the scheme’s benefit structure.
Likewise, some people may have chosen to take a lower percentage of – or even no – cash to get a higher income level.
These people will have the opportunity to ‘correct’ their LSA and LSDBA, so they accurately reflect the actual amount of tax-free cash taken. They, or their personal representatives, will be able to ask pension schemes to issue a transitional tax-free amount certificate to help calculate the corrected value of the new allowances.
