Around 18 years ago, in 2006, the government introduced a policy to cap the size of a pension fund an individual could accumulate before facing potential tax penalties. This cap is known as the pension lifetime allowance (LTA). At its peak, the LTA was as high as £1.8 million but more recently, it was reduced to £1,073,100.
To many, a tax-free pension savings limit of over a million pounds might seem like it only affects the very wealthy. However, this is misleading. Many people with past service in final salary or defined-benefit schemes can reach this limit, especially when combined with workplace pensions.
The current government’s decision to eliminate the LTA entirely from April 2024 appears to be good news for many pension savers. However, as is often the case with tax legislation, the reality is more complex. The LTA is being replaced with two new regulatory limits:
These new allowances mean that people can take as much taxable pension income as they want without being tested against the LTA or facing an additional tax charge. However, the allowances control the level of tax-free lump sums that can be taken both during retirement and by beneficiaries after a member’s death.
The lump sum allowance, set at £268,275 (25% of the last LTA of £1,073,100), measures the tax-free lump sum taken while living, such as pension commencement lump sums and the tax-free part of any uncrystallised pension fund lump sums. This could vary if the individual has arranged any LTA pension protection.
The lump sum and death benefit allowance, usually set at £1,073,100, measures the tax-free lump sums taken by the LSA, plus any serious ill-health lump sums and tax-free lump sums paid out on death to beneficiaries.
The new regime aims to allow increased taxable income for individuals and government revenue while prudently limiting the tax-free cash that can be used outside retirement planning. For those who have already taken some benefits and may have more to crystallise in the future, the government has introduced transitional rules. These rules will reduce future allowances (for both LSA and LSDBA) based on previous lump sums taken, and this reduced limit will be used for testing benefits taken after April 6, 2024.
The applicable limit will depend on individual circumstances and whether pension protection has been used. If you’re affected by these changes, seeking financial guidance is crucial to ensure you stay within regulated allowances and maximize your tax-free cash.
The takeaway is that even moderate earners, not just high earners, may be impacted by these changes. With something as important as your retirement future, support from a financial planner can bring peace of mind knowing you are on track to meet your goals.
Editor’s notes:
March 2024
The information within this article is based on our understanding of current legislation, which is subject to change, and should not be regarded as advice or recommendation. Readers should seek appropriate guidance from their financial planner.
