This guide is for financial advisers only. It must not be distributed to, or relied on by, customers. The information on this page is based on our understanding of legislation as at 6 April 2024.
Background
In the 2023 Spring Budget the Chancellor announced that the lifetime allowance (LTA) would be abolished from 6 April 2024. New regulations subsequently came into force on 6 April 2024 to remove the LTA from pension taxation rules. In its place, two new allowances have been introduced, namely the lump sum allowance (LSA) and the lump sum and death benefits allowance (LSDBA). There is an additional allowance for overseas transfers, which is covered in our separate guide: (Transfers | Adviser | Aegon).
This technical guide covers:
- the LSA and LSDBA,
- the transitional arrangements (to follow),
- relevant benefit crystallisation events (to follow),
- how protections and enhancement factors affect the LSA and LSDBA (to follow), and
- how scheme-specific tax-free cash will be dealt with under the new rules (to follow).
From 6 April 2024 a lump sum allowance (LSA) of £268,275 will apply (there is currently no mechanism within the draft legislation that will allow the LSA to increase). An individual may be entitled to a higher LSA if they hold a valid lifetime allowance protection.
The LSA applies when a ‘relevant benefit crystallisation event’ (RBCE) occurs on or after 6 April 2024. For the purposes of the LSA an RBCE occurs when one of the following ‘relevant lump sum’ payments are paid:
- pension commencement lump sum (PCLS)
- uncrystallised funds pension lump sum (UFPLS)
- stand-alone lump sum (SALS)
Each time an entitlement to a PCLS or UFPLS arises the value of the individual’s LSA will be reduced by the monetary amount of the relevant tax-free payment. So the LSA will be reduced by the full amount of any PCLS paid, but only by the tax-free element of an UFPLS.
For example, if an individual who has never received a lump sum payment from a pension scheme receives a PCLS of £50,000 their LSA will be reduced from £268,275 to £218,275. If instead a UFPLS of £50,000 was paid which included a tax-free amount, the LSA would be reduced by £12,500, i.e. 25% of the £50,000 UFPLS, to £255,775.
However, where an individual exercises a right to take more than 25% tax-free cash (i.e. where they have tax-free cash protection), the LSA is only reduced by 25% of the total crystallised value, rather than the full monetary amount of the tax-free cash paid.
The tax-free treatment of a SALS differs depending upon whether the entitlement arises because the member:
- Holds primary protection with protection of lump sum rights in excess of £375,000 but does not hold enhanced protection with protection of lump sum rights.
- Holds enhanced protection with protection of lump sum rights in excess of £375,000.
- Was entitled on 5 April 2006 to take all of their benefits in an occupational pension scheme or section 32/deferred annuity contract as a tax-free lump sum.
For 1. and 2. the LSA is reduced by the full amount of the SALS whilst for 3. the LSA is reduced by 25% of the lump sum paid.
When an RBCE occurs, the tax-free amount is subject to the limits set out in this table:
Lump Sum Payment |
Maximum tax-free payment |
|---|---|
PCLS |
The lower of;
|
UFPLS
|
The lower of;
|
SALS - when the member does not hold enhanced protection but does hold primary protection with protection of lump rights in excess of £375,000 |
The lower of;
|
SALS when the member holds enhanced protection and with protection of lump rights in excess of £375,000 |
The maximum SALS that could have been paid to the individual tax free on 5 April 2023, less the aggregate of any SALS or PCLS amounts paid after this date.
|
SALS where , on 5 April 2006, the members maximum lump sum entitlement under an occupational pension scheme or deferred annuity is equal to the value of their benefits in the scheme. |
The lower of:
|
Where the amount of the tax-free payment that could normally be paid is greater than the individual’s remaining LSA or LSDBA the tax-free amount is limited to the lower of the remaining LSA or remaining LSDBA. The remainder of the payment is subject to income tax. This option is not available for PCLS as the payment is limited to lower of the remaining LSA or LSDBA. Once the first of the LSA or LSDBA has been reduced to nil no further PCLS can be paid. However, it may be possible to pay the excess as a Pension Commencement Excess Lump Sum (PCELS) or as an UFPLS payment. The full amount of such payments are subject to income tax at the recipient's marginal rate.
Pension commencement excess lump sums (PCELS)
HMRC said the following in their Newsletter 159 published in April 2024:
"A PCELS cannot be paid where another authorised lump sum could be paid instead — therefore, if the individual could be paid an UFPLS under tax legislation (section 166 of Finance Act 2004) they cannot be paid a PCELS, even if their particular scheme rules do not permit the payment of an UFPLS"
Order of RBCEs
Where two or more RBCEs occur on the same day it is for the individual to decide the order in which they are to be treated as becoming entitled to the lump sums for the purposes of measuring the lump sums against the LSA.
In addition to the LSA, individuals will also be subject to a Lump sum and death benefit allowance (LSDBA). The LSDBA is set at £1,073,100 from 6 April 2024 and as with the LSA, the legislation does not include any mechanism to increase this limit in the future. An individual may be entitled to a higher LSDBA if they hold a valid lifetime allowance protection.
The LSDBA is reduced each time a RBCE occurs. The definition of RBCE in relation to the LSDBA differs to the definition used in respect of the LSA. In the context of the LSDBA an RBCE means any relevant lump sum or any relevant lump sum death benefit.
During an individual’s lifetime their LSDBA is reduced by be the following relevant lump sums:
- pension commencement lump sums (PCLS)*,
- stand-alone lump sums (SALS),
- serious ill health lump sums (SIHLS), and
- the tax-free element of any uncrystallised funds pension lump sums (UFPLS)
*where an individual exercises a right to take more than 25% tax-free cash (i.e. they have tax-free cash protection) the full amount of the tax-free cash paid reduces their available LSDBA.
On death, any authorised lump sum death benefit paid is treated as a relevant lump sum death benefit, with the exception of:
- a charity lump sum death benefit lump, or
- a trivial commutation lump sum death benefit.
Lump sum death benefits from crystallised funds
HMRC confirmed in their LTA Abolition FAQs, published in March 2024 that the payment of a lump sum death benefit from benefits that were crystallised before 6 April 2024 do not reduce the LSDBA as they were tested against the LTA when they were first crystallised.
Further legislation is required to achieve this outcome. HMRC are also considering whether a new reporting requirement needs to be legislated for to deal with transfers of rights that crystallised before 6 April 2024.
Here's a link to the FAQs - see Q 17.
Taxation of lump sum death benefits
The tax-free amount of each relevant lump sum death benefit (LSDB) counts towards the LSDBA where the member was aged under 75 at the time of death and the lump sum is paid within two years of the date the scheme administrator was first notified or became aware of the death of the member.
The taxation of payments made where the member was aged 75 or over when they died or those paid more than two years after the scheme administrator should have first been aware of the member’s death will not change - these remain taxable. See the table below for a breakdown of how each lump sum death benefit is treated for tax purposes from 6 April 2024, depending upon the circumstances that apply at the time of death.
Lump sum death benefit (LSDB) |
Member dies on, or after, 75 |
Settled more than two years from notification |
Dies under 75, settled within two years |
Uncrystallised funds LSDB |
Full amount subject to income tax if paid to a qualifying person.. Full amount subject to the special lump sum death benefits charge if paid to a non- qualifying person. |
Full amount subject to income tax if paid to a qualifying person. Full amount subject to the special lump sum death benefits charge if paid to a non- qualifying person. |
Tax free if within member’s remaining LSDBA. Any amount that exceeds the member’s remaining LSDBA is subject to income tax.* |
Drawdown pension fund LSDB |
Full amount subject to income tax if paid to a qualifying person. Full amount subject to the special lump sum death benefits charge if paid to a non- qualifying person. |
Full amount subject to income tax if paid to a qualifying person. Full amount subject to the special lump sum death benefits charge if paid to a non- qualifying person. |
Tax free if within member’s remaining LSDBA. Any amount that exceeds the remaining LSDBA is subject to income tax.*
|
Flexi access drawdown LSDB |
Full amount subject to income tax if paid to a qualifying person. Full amount subject to the special lump sum death benefits charge if paid to a non- qualifying person. |
Full amount subject to income tax if paid to a qualifying person. Full amount subject to the special lump sum death benefits charge if paid to a non- qualifying person. |
Tax free if within member’s remaining LSDBA. Any amount that exceeds the remaining LSDBA is subject to income tax.* |
Annuity protection LSDB |
Full amount subject to income tax if paid to a qualifying person. Full amount subject to the special lump sum death benefits charge if paid to a non- qualifying person. |
Not applicable – no ‘two-year rule’. |
Tax free if within member’s remaining LSDBA. Any amount that exceeds the member’s remaining LSDBA is subject to income tax.* |
Defined Benefit LSDB |
Full amount subject to income tax if paid to a qualifying person. Full amount subject to the special lump sum death benefits charge if paid to a non- qualifying person |
Full amount subject to income tax if paid to a qualifying person. Full amount subject to the special lump sum death benefits charge if paid to a non- qualifying person. |
Tax free if within member’s remaining LSDBA. Any amount that exceeds the member’s remaining LSDBA is subject to income tax.* |
Pension Protection LSDB |
Full amount subject to income tax if paid to a qualifying person. Full amount subject to the special lump sum death benefits charge if paid to a non- qualifying person. |
Not applicable – no ‘two-year rule’ |
Tax free if within member’s remaining LSDBA. Any amount that exceeds the member’s remaining LSDBA is subject to income tax.* |
* the lump sum is paid by the scheme administrator without deducting income tax.
Visit our Death benefits guide for more information about qualifying and non-qualifying persons: Death benefits | Adviser | Aegon.
Once the LSDBA has been reduced to nil any subsequent relevant lump sums (except PCLS, which can’t be paid once LSDBA is nil) or relevant lump sum death benefits will be subject to income tax at the marginal rate of the recipient. Where income tax is due following the payment of a relevant lump sum death benefit it's the responsibility of the legal personal representatives to notify HMRC that tax is due and HMRC will then notify the beneficiaries of their liability to income tax. HMRC intend to update this process from 6 April 2025 to introduce new guidance for LPRs and a form for them to complete.
Inherited death benefits and the LSDBA
In HMRC's LTA Abolition FAQs, published in April 2024, it was confirmed that where a dependant inherits a member’s drawdown fund or a dependant, nominee or successor inherits a member’s flexi-access drawdown fund, any lump sum paid on the death of the dependant, nominee or successor will count towards their LSDBA rather than the LSDBA of the original member or the recipient of the lump sum. Also, it’s the age and date of death of the dependent, nominee or successor that determines the tax treatment of any lump sum death benefit being paid. Any tax-free lump sum death benefit that exceeds the dependent’s, nominee’s or successor’s remaining LSDBA will be taxable.
Here's a link to the FAQs - see Q 22.
Order of RBCEs
Where more than one RBCE occurs in relation to the payment of lump sum death benefits in respect of an individual, they are to be treated for the purposes of the LSDBA as occurring;
- immediately prior to the individual’s death,
- immediately after the payment of any PCLS to which the individual becomes entitled under section 166(2) of FA2004, and
- in such order as may be decided by the LPR.
Therefore, where there are multiple lump sum death benefit payments paid it will be for the LPR to decide the order in which the payments are made which will in turn determine which payments are subject to income tax when the LSDBA is exhausted.