Navigating the abolition of LTA and the impact on tax-free lump sums 

The main change is a new set of rules being implemented to limit the tax-free lump sum payments.

While the changes mean there will be no limits on any funds used to provide a taxable pension income, there are limits on the tax-free lump sums payable both during lifetime and/or on death.

Background

Although no LTA charges have applied since April 6 2023, for tax year 2023-24 the LTA framework has remained in place. 

This was an interim measure while HMRC worked on a new set of rules to abolish the LTA entirely from April 6 2024.

While there is still some clarity needed in the run up to April 6, we have a good idea of how the new rules are likely to work and the impact it is likely to have. 

The aim of the new rules was to ensure that there were no fundamental changes to the way pensions work. 

However, with the abolition of the LTA, new rules needed to be introduced to limit lump sum payments that were previously restricted by the LTA. 

As if there were not enough acronyms around pensions already, there are now two more with the introduction of two new limits which are: 

• the lump sum allowance (LSA); and 
• the lump sum and death benefits allowance (LSDBA). 

The LSA

This new rule limits the tax-free lump sums payable to the member in their lifetime from tax-free cash and the tax-free elements of uncrystallised funds pensions lump sums (UFPLS). 

The limit is set at £268,275 but can be higher for those with LTA protections.

The LSA of £268,275 is a maximum.

Tax-free cash entitlement if lower than the new LSA has not changed and is still limited to 25 per cent of the uncrystallised funds or one-third of the amount designated to provide income.

Example

Henry has an uncrystallised pension fund worth £1,000,000. 

His tax-free cash would be limited to 25 per cent of the uncrystallised funds, ie £250,000. 

He would have used 93.18 per cent of his lump sum allowance. 

Where the client has taken any LSA during their lifetime, this will reduce the available LSDBA paid on death.

However, if Henry’s uncrystallised pension fund was worth £1,600,000 and had no protection, as the tax-free cash entitlement is limited to the lower of 25 per cent of the value of the funds or the LSA, he would be limited to taking a maximum of £268,275. 

Any lump sum paid in excess of the limits will be subject to income tax at Henry’s marginal rates. 

Anything paid as pensions income will not be tested and will be subject to income tax in the normal way.

The LSDBA

This new rule limits the amount of tax-free lump sum that can be paid both in lifetime and on death. 

The LSDBA is set at £1,073,100 but can be higher for those with LTA protections.

It is also important to be aware that where the client has taken any LSA during their lifetime, this will reduce the available LSDBA paid on death.