The shake-up to pensions proposed earlier this year is finally coming to fruition.
Starting from April 2024, the Lifetime Allowance (LTA) is being scrapped. That’s the limit on how much you can hold in your pension without facing extra taxes. Instead, we’re getting two new allowances to keep an eye on. These are the lump sum allowance and the lump sum & death benefit allowance.
What is the lump sum allowance?
The Lump Sum Allowance (LSA) limits the tax-free lump sums a person can receive from their pensions throughout their lifetime. The maximum tax-free lump sum from a pension is still 25% of its value. However, it is now subject to the LSA cap of £268,275 (25% of the current Standard LTA of £1,073,100). If someone takes out benefits from their pensions above the LSA limit, they will have to pay Income Tax on it.
For example, Janet has a SIPP worth £1.5M and takes £300,000 out as a lump sum. £268,275 would be tax free and the remainder would be subject to income tax.
What’s Changing with Pension Death Benefits?
The Lump Sum and Death Benefit Allowance (LS&DBA) caps the amount of lifetime tax-free lump sums and tax-free death benefits that can be received. This allowance applies to both tax-free lump sums paid during life and after death. It is currently set at £1,073,100, the same as the old lifetime allowance. As a result, any tax-free cash an individual takes during their lifetime will reduce the amount available for lump sum death benefits.
For example, John has a SIPP worth £1M and takes £250,000 tax-free cash this tax year. If he were to die before age 75, the maximum tax-free lump sum death benefit which could be paid would be £823,100 (£1,073,100 less the £250,000).
Where someone receives death benefits over the LS&DBA, the excess would be added to their income for income tax purposes.
It had been mooted that death benefits used to generate income through drawdown or an annuity could be taxable. However, this decision has been reversed. Any death benefits within the LS&DBA are tax-free if the person who passed them down died before their 75th birthday.
How does this affect me if I have already started taking my pensions?
There will be a transitional calculation to figure out how this impacts your new allowances. If you have already used up your “old” LTA, you have also used up your new allowances.
What if I have small pension pots?
If you’ve got small pension pots, these amounts should not eat into your new allowances. That means you can still take these small sums without worrying about losing tax benefits on larger amounts.
What if I had LTA protection?
For those with LTA enhancements, your rights to a higher tax-free element are safe.
