The lump sum allowance

What is the Lump sum allowance?

The government announced in March 2023 that it planned to scrap the lifetime allowance.  But before we got too excited, it also announced there would instead be a limit on the amount of tax-free lump sums individuals can take from their pensions, as well as the amount of tax-free death benefits payable when they die. This article only looks at tax-free lump sums paid during an individual’s lifetime.

The LSA is set at £268,275, which is 25% of the 2023/24 LTA of £1,073,100.  There aren’t currently any plans for this to increase, for example by the Retail Prices Index (RPI). 

Some people might have a higher LSA, for example if they’ve been granted one of the fund protections.  If they have one of the protections, they’ll normally either have:

• a fixed monetary amount of LSA (e.g. fixed protection 2012 has an LSA of £450,000, 25% of the protected amount of £1,800,000) or;
• the lower of a monetary amount and 25% of the protected amount (e.g. Individual protection 2014 gives a LSA of the lower of 25% of the protected amount and £375,000, which is 25% of the maximum protected amount of £1,500,000)

This varies based on the type of protection held, and we’ll cover it fully in a separate article.

There’s also the LSDBA, a separate limit on tax-free lump sum and death benefits which is initially set at £1,073,100, i.e. the same as the LTA before 6 April 2024.  We cover more on that topic in a separate article.

How does the LSA work?

The LSA is used when an individual takes either a pension commencement lump sum (PCLS) or an uncrystallised funds pension lump sum (UFPLS) from 6 April 2024.  Only the tax-free element of the UFPLS will count towards the LSA.  These are ‘relevant benefit crystallisation events’ (RBCEs). When an RBCE takes place, the tax-free amount that’s paid cannot exceed the permitted maximum. Broadly speaking, the permitted maximum is:

• For PCLS, the lower of
  • 1/3 of the amount used to provide the related pension income (annuity/drawdown/scheme pension);
  • The individual’s remaining LSA; or
  • The individual’s remaining LSDBA
• For UFPLS, the lower of:
  • 25% of the value of the lump sum
  • The individual’s remaining LSA; or
  • The individual’s remaining LSDBA.

To work out the amount of available LSA an individual has, take their starting LSA (normally £268,275) and:

• deduct the monetary value of any tax-free lump sum amounts paid at each RBCE after 6 April 2024, and
• make allowance for any pre-6 April 2024 Benefit Crystallisation Events (BCEs)

Note that the individual must also have some lump sum and death benefits allowance (LSDBA) available on or after 6 April 2024 in order the take lump sum payments tax-free.

How do you allow for benefits taken before 6 April 2024?

If an individual took any pension benefits before 6 April 2024, this needs to be taken into account when they have an RBCE.

There are two methods available for working out the remaining LSA:

1. default position – where a transitional tax-free amount certificate is not held, and
2. using a transitional tax-free amount certificate.

The LSA available at an RBCE is £268,275 reduced by either 25% of the LTA an individual has already used, as if the BCE(s) occurred immediately before 6 April 2024, or by the amount shown on their ‘transitional tax-free amount certificate’. The LSA used up by any other RBCEs taken on or after 6 April 2024 also need to be deducted to find out the amount of LSA remaining.

This means if the BCE happened in a tax year where the LTA wasn’t £1,073,100 an adjustment needs to be made. Here’s how it’s calculated:

Value of pre-6 April 2024 BCE x (£1,073,100 /LTA at the time the BCE was taken)

This calculation should be repeated for each BCE to give the total amount of lifetime allowance used.

Default method

Example – Susan took drawdown and tax-free cash in the 2011/12 tax year, crystallising £200,000, of which £50,000 was PCLS.  She then took an UFPLS in the 2017/18 tax year of £400,000, which included a tax-free amount of £100,000.  At her first RBCE in 2024/25, under the default method set out under the transitional arrangements, Susan has already used the following amount of her LTA:

BCE1 in 2011/12

£200,000 x (£1,073,100/£1,800,000) x 25% = £29,808

£400,000 x (£1,073,100/£1,000,000) x 25% = £107,310

Her LSA available will be:

£268,275 – (£29,808 + £107,310) = £131,157

Note that if an individual had used up all their LTA before 6 April 2024, they won’t have any LSA under this calculation method.

Pre-commencement pensions

Where a pre-commencement pension (one which started before 6 April 2006) has already been tested at the first BCE after 6 April 2006 and before 6 April 2024, it will simply be included in the amount of LTA already used when an individual comes to their first RBCE.

However, if an individual with a pre-commencement pension has no BCEs between 6 April 2006 and 5 April 2024, the pre-commencement pension triggers a notional RBCE that ‘takes place’ immediately before the first RBCE so will use up some of the individual’s LSA and LSDBA.

Where an individual provides a transitional tax-free amount certificate

Where an individual provides a ‘transitional tax-free amount certificate’ (see below), the LSA available is £268,275 reduced by the amount shown as the 'lump sum transitional tax-free amount’ on the certificate – this is the amount of all PCLS and tax-free elements of UFPLS that the individual has taken before 6 April 2024.  The certificate will also show the individual’s lump sum and death benefit transitional tax-free amount.

Example – Sanjeev crystallised £400,000 of benefits in 2023/24, opting to take PCLS of £50,000 and moving the remainder to drawdown.  He has a transitional tax-free amount certificate showing that his lump sum transitional tax-free amount is £50,000.  The amount of LSA now available to Sanjeev will be:

£268,275 - £50,000 = £218,275

It’s worth noting that under this calculation method, it may be possible to get PCLS where all of the LTA was used up prior to 6 April 2024 if the individual took less than 25% PCLS at one or more BCEs.

If either calculation produces a negative amount, the LSA is nil.

What about small lump sums?

HMRC have confirmed that individuals are required to have some LSA left to take a winding-up lump sum or trivial commutation lump sum – they don’t need to have enough to cover the whole payment. However, this isn’t a requirement for taking a small pots lump sum.

Transitional tax-free amount certificates

An individual (or their personal representatives if the member has died) can request the scheme administrator or Trustees of any scheme they’re a member of to provide them with a Transitional tax-free amount certificate that shows the amount of the individual’s lump sum transitional tax-free amount (as well as lump sum and death benefit transitional tax-free amount). The lump sum transitional tax-free amount is the sum of all PCLS and the tax-free elements of UFPLS payments the individual has become entitled to before 6 April 2024.  The certificate will be used to calculate the LSA available at that and subsequent RBCEs. 

Importantly, the application can only be made before the first RBCE.  If an RBCE has already happened after 6 April 2024, no application can be made and the LSA available will be calculated using the default calculation.