What are pension lump sum allowances and how do they work?

Prior to 6th April 2024, the Lifetime Allowance (LTA) was £1,073,100.

Before 6th April 2023, the Lifetime Allowance (LTA) was the maximum value of benefits that could be taken from a registered pension scheme without being subject to the Lifetime Allowance charge, unless appropriate protections applied. The Lifetime Allowance charge was a tax charge, which could be up to 55% of the benefits being taken. 

The Lifetime Allowance charge was removed from 6th April 2023. In its place, between 6th April 2023 and 5th April 2024, benefits that exceeded the Lifetime Allowance would be taxed at the recipient’s marginal rate of income tax.

Benefits were tested against the lifetime allowance when a benefit crystallisation event happened. This included when moving a pension fund into drawdown, payment of a lump sum from a pension, transfer to a qualifying recognised overseas pension scheme (QROPS) and other benefit types.

It was possible to protect pension benefits in excess of the lifetime allowance, by taking out one of several different forms of HMRC Lifetime Allowance protection.

The standard Lump Sum Allowance is £268,275. Your available allowance may be more or less than this if you have already taken pension benefits before 6 April 2024, or if you hold lifetime allowance protection. It will also be reduced when you take relevant tax-free lump sums from 6 April.

The Lump Sum Allowance applies to any Pension Commencement Lump Sum (PCLS) and to the tax-free part of any Uncrystallised Funds Pension Lump Sum (UFPLS) you take. These lump sums are also tested against your available Lump Sum and Death Benefit Allowance.

The amount you’ll be able to take as a tax-free lump sum will usually be the lower of 25% of the benefits being taken, your available Lump Sum Allowance, and your available Lump Sum and Death Benefit Allowance.

Any transfers you made to a Qualifying Recognised Overseas Pension Scheme (QROPS) prior to 6th April 2024 will have been tested against your lifetime allowance. From 6 April 2024 these transfers are now tested against your Overseas Transfer Allowance instead.

Your Overseas Transfer Allowance will be the same amount as your Lump Sum and Death Benefit Allowance, but it won’t be reduced by tax-free lump sums you take on or after 6 April 2024. It will only be reduced by the value of transfers you make to QROPS.  

If you make a transfer to a QROPS and the transfer value is more than your available Overseas Transfer Allowance, the amount exceeding your allowance will be subject to the Overseas Transfer Charge. This is a flat rate of tax currently set at 25%.

If you’ve already taken pension benefits, you’ll have received a statement showing how much of your lifetime allowance was used. This will have shown lump sums as well as amounts moved into drawdown or used to buy an annuity. In future, you’ll only receive a statement for the new allowances when you take a tax-free lump sum.

The standard Lump Sum and Death Benefit Allowance is £1,073,100. Your available allowance may be more or less than this if you have already taken pension benefits before 6 April 2024, or if you hold lifetime allowance protection. It will also be reduced when relevant lump sums are paid out from 6 April.

If you started taking benefits from a pension before 6 April 2024, your available allowances will be reduced.'

If you took benefits before 6 April 2006, but haven’t taken anything since, then the annual amount of income you’re taking, or are entitled to take, will be used to calculate how much of the new allowances you’re deemed to have used. The amount will be calculated for you if you take a tax-free lump sum from 6 April.

If you took pension benefits between 6 April 2006 and 5 April 2024 were tested against your lifetime allowance:

• Your available Lump Sum Allowance will be reduced by 25% of the total lifetime allowance you’ve used.

• Your available Lump Sum and Death Benefit Allowance will also be reduced by 25% of the lifetime allowance you’ve used, unless you received a serious ill-health lump sum before your 75th birthday or any lump sum death benefits have been paid before 6 April 2024. If either of these apply, then 100% of the lifetime allowance you’ve used will be deducted from your Lump Sum and Death Benefit Allowance.  

If you’ve already used all your lifetime allowance, your new allowances will be £0.

In some circumstances, if you’ve used lifetime allowance but didn’t take the maximum amount of tax-free cash you were entitled to, or if the maximum tax-free cash was lower than 25% of the Lifetime Allowance used, then you might be able to increase your available lump sum allowances by applying for a transitional tax-free certificate. HMRC only expect this to apply to a small number of people.

The table below is only intended to provide a high-level summary of how existing protections will apply to the Lump Sum Allowance and Lump Sum and Death Benefit Allowance from 6 April 2024.   

The Lump Sum and Death Benefit Allowance applies when you take a Pension Commencement Lump Sum and to the tax-free part of an Uncrystallised Funds Pension Lump Sum. It also applies to serious ill-health lump sums paid before you reach age 75, and lump sum death benefits if you die before reaching 75.

When benefits are paid out after your death, the Lump Sum and Death Benefit Allowance is only applied to any tax-free lump sums. If benefits are used to provide a beneficiary with a drawdown pension, they will not be tested against your allowances, and income will usually be tax-free if you die before 75. It had been suggested this would change from 6 April 2024, but this change isn’t included in the current legislation.

If you’ve taken pension benefits that were tested against the lifetime allowance, but you took tax-free lump sums of less than 25%, the standard approach set out above will reduce your available allowances by more than the tax-free lump sums you’ve taken.

If this applies to you, you can apply to the scheme administrator of any pension scheme you’re a member of for a transitional tax-free amount certificate. You will need to apply for the certificate before you take any tax-free lump sum tested against your lump sum allowances. Find out more here.

If you turn 75 on or after 6 April 2024, your pension benefits won’t need to be tested against your allowances. Under the new rules, your benefits will only be tested when you take a tax-free lump sum or transfers to an overseas pension scheme.

If you are 75 before 6 April 2024, your benefits will still need to be tested against the lifetime allowance.

If you meet the criteria, it’s still possible to apply for Fixed Protection 2016 and Individual Protection 2016, but the Government have announced an application deadline of 5 April 2025. If you qualify for an enhancement factor to increase your allowances, the deadline for applying for these is also 5 April 2025.  

If you take a lump sum that’s more than your available allowances, the excess amount will be subject to tax.

For lump sums paid in your lifetime, we’ll calculate and deduct any income tax due on amounts over your available allowances before we pay the lump sum to you. If we don’t already hold a tax-code or P45 for you for the current tax-year, we will apply emergency tax on a month one basis to the taxable amount. This may result in an overpayment of income tax. If so, you will be able to reclaim the overpayment from HMRC.

For lump sum death benefits paid to an individual, we will pay the lump sum without deducting any income tax. It will be for the personal representative or executor dealing with your estate to notify HMRC about any amount exceeding your available allowances. HMRC will then arrange for the payment of income tax from the beneficiary who received the lump sum. If the lump sum isn’t paid to an individual or to a charity, the special lump sum death benefit tax charge of 45% may still apply. Where this is the case, we’ll deduct the tax charge before paying the lump sum.