Understanding pension allowances

Before 6 April 2023 there was a limit to how much you could save into your pension account (£1,073,100) before you would have to pay a tax charge. This limit was known as the Lifetime Allowance (LTA), which has now been abolished.

Whilst the removal of this allowance has been welcomed, at the same time two new allowances have been introduced; the Lump Sum Allowance (LSA) and the Lump Sum Death Benefit Allowance (LSDBA).  In this blog we’ll look at what these are and how they might affect you.

Lump Sum Allowance

The LSA limits how much you can withdraw from your pension tax-free over your lifetime. For most people this amount is 25% of the pension fund value. The LSA sets the maximum at £268,275 for most people (which is 25% of the previous LTA).

If you’ve never taken anything from your pension before, this is a simple calculation.  Let’s look at an example, if Joe draws £100,000 tax free from his pension, his remaining LSA is £168,275.  He can continue to draw tax free cash (up to 25% of the pension value) until he reaches zero. After that, any further withdraws are subject to income tax.

If you are fortunate to hold Fixed Protection, Individual Protection, Enhanced Protection, or Primary Protection, your LSA is set at 25% of the protected amount.  The most significant change to the rules for those with Fixed or Enhanced Protection, is that these would previously have been lost if you continued to contribute or accrue benefits. You are now able to contribute to your pension again without invalidating your protection or losing the higher LSA, which is a great opportunity that hasn’t been available to some investors for up to 18 years.

If you took pension benefits before 6 April 2024, particularly if you received benefits from a pension or purchased an annuity between 2018 and 2020, there is the possibility that your LSA could be higher than £268,275. However, this won’t apply to everyone so seeking professional advice is highly recommended to ensure you don’t pay unnecessary tax.

Those who have either pension credits or debits from divorce are advised to seek advice as to how this affects their LSA.

Lump Sum Death Benefit Allowance

Now onto the second new allowance, LSDBA.  This allowance limits the total capital lump sums that can be paid from your pension in your lifetime and after your death.  As LSDBA only tests lump sums, in our view, it is easily avoidable if your pension plans are properly established, with the correct features, and your beneficiaries have been named correctly. Good advice in this area should mean that most people never incur a LSDBA charge.

In summary, while these allowances simplify pension rules, it’s essential to seek professional advice if your unsure about your specific situation.

If you would like to know more, please contact one of our financial planners here.