So what is the pensions Lifetime Allowance (LTA) for UK pensions. It was the maximum amount of pension savings you could build up without paying an extra tax charge. But it was fully abolished on April 6th 2024 by Jeremy Hunt (the chancellor as part of his Spring Statement).
It has since been replaced by 2 new tax based limits. Which means in effect there is no limit into how big your pension pots can accumulate.
So what are these new changes:
- Lump Sum Allowance (LSA) – The Limit: £268,275
How it works: This is the maximum amount of tax-free retirement lump sums. (such as your 25% tax-free cash entitlement) you can take across your lifetime. - The Rules: If you exceed this available allowance, the excess above the lump sum is then subject to your marginal rate of income tax.
- Lump Sum and Death Benefit Allowance (LSDBA) – The Limit: £1,073,100
How it works: This is the maximum amount of tax-free lump sums you can take in your lifetime. Plus any tax-free lump sum death benefits paid if you pass away before age 75.
The Rules: Any lump sums that exceed this limit. Are then generally subject to income tax payable at your marginal rate.
So what rates of income tax apply:
Tax free personal allowance: 0 to £ 12,570 per tax year
Basic rate (20%): £ 12,571 to £ 50,270
Higher rate (40%): £ 50,271 to £ 125,140
Additional rate (45%): over £ 125,140
Also your personal allowance will reduce if your income is over £ 100,000 – at a rate of £2 of income above that threshold.
The above allowances apply each tax year and are currently frozen until 6th April 2031.
Some key exceptions:
By taking a regular pension income (such as an annuity or defined benefit
scheme payments) no longer counts towards these lump sum limits.
If you took tax-free cash from your pension before April 6 2024, under told rules. Then a standard transitional calculation usually applies. (generally deemed to use up 25% of your available allowances).
If you had previously applied for pension protection prior to its abolition. You may be entitled to a higher LSA and LSDBA limit. Under the rules of type and value placed under that protection.
What about overseas limits:
Then you have the Overseas Transfer Allowance (OTA). A lifetime cap on how much you can move from UK registered pensions to a Qualifying Recognised Overseas Pension Scheme (known as QROPS) without any additional extra UK tax charge.
For most people the OTA is set to £1,073,100, but it could be higher if you hold valid LTA style protections.
So what key events count against these new rules:
Taking a tax-free lump sum (PCLS):
So when you crystallise your pension pot and access. It counts against your total allowance of £ 268,275. Plus you can take a tax-free cash across numerous schemes, subject to the scheme rules. Most schemes allow you to take 25% tax free from each pot.
Simple example: if you have a DC pot worth £ 100,000 you should be able to access £ 25,000 as tax-free cash and leave the rest invested within the pension wrapper. This is known as drawdown where the remaining funds stay invested. Or you use the remaining funds to buy an annuity, to provide guaranteed income.
The scheme administrator or pension provider will calculate the pot value at time of accessing. They will complete a scheme test, and duly notify HMRC on your behalf.
If you take more tax-free cash than £ 267,275, it would be taxed at source by your pension provider. There should be no need to complete self-assessment forms or inform HMRC. Unless you have income sources, businesses etc and you complete them forms anyway.
Number of lump sums (UFPLS):
I have tried to avoid technical jargon, but your pension provider will call this option: Uncrystallised funds pension lump sum. So on each each normally 25% is tax-fee and 75% is then taxable at source and classed as earned income.
Simple example: If you withdraw £ 10,000 on each withdrawal £ 2,500 (25%) is tax-free and £ 7,500 (75%) is taxable on every lump sum paid out to you.
So again, each time a withdrawal is made it is tested against both the LSA & LSDDBA by your appropriate pension provider.
See my blog post about how UFPLS works: https://moneyminted.co.uk/how-to-access-your-pension-by-a-number-of-lump-sums
What about serous ill-health:
If you happen to have serious ill-health, so less than 12 months to live.
Your provider at their discretion may allow you to access the pot earlier than age 55 (current MPA).
It could be paid to you completely tax-free within the LSDBA limits mentioned above.
If you are over the above threshold then income tax will apply.
Hopefully this event doesn’t occur to an individual, but most people unfortunately are not aware of this key consideration.
If you do happen to obtain serious ill-health condition, then contact your DB or DC pension provider. You should provide them with suitable doctors report or medical evidence.
What about death benefits paid to beneficiaries:
Under current rules, if somebody dies below age 75. Then a DC pension can be paid completely income tax free to a beneficiary, such as spouse, partner, children, siblings, grandchildren. As long as they claim and act upon within 2 years of the date of the death for policy holder.
If they fail to act they within the 2 year timeframe, it will then be subject to income tax payable at their marginal rate.
They could access the pot via a one-off lump sum, buying an annuity or accessing via drawdown (FAD). But they won’t have the option to access an inherited pot vi UFPLS. So again check with the pension provider about the products and options available to you as a beneficiary.
An inherited pot will not be tested against the LSA, but any excess above the LSDBA is taxed at the beneficiaries marginal rate.
Are there any proposed changes in future:
That unfortunately is the great unknown, you can only act within the rules and guidelines currently in place.
As we all knows pensions change over time such as A-day (back in 2006) the introduction of Pensions Freedom in 2015. Or the constant rumour each budget that the tax free lump sum of 25% will be lowered or abolished.
But 1 key point moving forwards it that the rules relating too pensions and IHT will be changed in April 2027.
At present any funds held within the pension wrapper are currently free from IHT. But the rules will change in April 2027 from a recent budget announcement.
In the past it was seen as good future tax planning, in that pension could be passed onto family IHT free.
This could prove to very valuable, especially if you had a large property or assets and your estate was valued over the IHT threshold currently set at £ 325,000 per person.
This could prove to be a double tax whammy as beneficiary could pay both income tax and IHT on a pension pot. They could pay a fine or interest charge it they fail to pay IHT amount within the 6 month timeframe to HMRC.
So stay ahead of the upcoming changes, a good source of knowledge could be to look at https://www.gov.uk/inheritance-tax
Remember:
If you found this blog post useful and informative please check out my other posts on savings, pension investing and investment books I recommend on http://www.moneyminted.co.uk
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