The 3 new “lump sum” pension allowances you need to know about

When the new tax year began on 6 April it brought about a significant change to the old lifetime allowance for pension savings. That has now been scrapped and three new lump sum allowances have instead come into force.

These three new lump sum allowances kick in when you start to take money out of your pension pot. Please note that it is only lump sums that these rules apply to. Any lump sums that exceed the allowances will be taxable at your marginal rate.

The removal of the lifetime allowance tax charge and the introduction of the new lump sum rules will be welcome news for many pension savers. As with any pension legislation, the rules can look highly confusing, but for someone who hasn’t taken any benefits before 6 April 2024, the new legislation is relatively straightforward.

The first new allowance is the lump sum allowance (LSA).

This enables you to take a maximum of £268,275 as your 25% tax-free lump sum. The numbers may look arbitrary but they are in fact 25% of the old lifetime allowance of £1,073,100. Your lump sum allowance (LSA) is £268,275 unless you have lifetime allowance protection. However, be aware that if you used some or all of your lifetime allowance before 6 April this year your LSA will be reduced.

If you do have lifetime allowance protection, then your allowance increases - to a total of £1.5m under Fixed Protection 14 - made up of a lump sum and death benefit allowance (LSDBA) of £1.5m and a lump sum allowance (LSA) of £375,000.

So how does that differ from the old rule?

The new lump sum allowance effectively replaces the old pension commencement lump sum (PCLS) rules. What that means in practice is that it will enable people with both a defined benefit scheme and a defined contribution scheme to take a lump sum from both pensions. Previously, when you claimed a defined benefit scheme pension which would have used up all your lifetime allowance, you wouldn’t have been left with any allowance to use on a lump sum from your defined contribution pension. Now you can claim from both.

What does that mean if I’m yet to start drawing my pension?

The new lump sum allowances give you all the more reason to make those further or additional pension contributions into your defined contribution pension in the run up to retirement, in the knowledge that you can claim a tax-free lump sum even if you also have a defined benefit pension as well.

The second allowance is the lump sum and death benefit allowance (LSDBA).

The next lump sum allowance to be aware of is the lump sum and death benefit allowance (LSDBA). There is a list of nine circumstances in which the LSDBA is triggered, all when a lump sum payment is made. These could be after taking a serious ill health lump sum or when a lump sum death benefit is paid. Each of us now has a LSDBA of £1,073,100. However, be aware that if you used some or all of your lifetime allowance before 6 April this year your LSDBA will be reduced.

So how does that differ from the old rule?

Before 6 April, if you took an initial £100,000 from your pension, triggering the old pension commencement lump sum (PCLS) and then took a further £300,000 from your pension pot you would have used up £400,000 of your lifetime allowance. Under the new rules, you can take the same two lump sums, but only the £100,000 PCLS payment will count towards your LSA and your LSADBA.

What happens in the case of serious ill health?

In the case of a serious ill health lump sum, if you’re under 75, haven’t yet taken money from your pension and have fewer than 12 months to live, you can, in theory, withdraw a lump sum up to your remaining LSDBA limit tax-free. This tends not to happen in many cases though, because for inheritance tax (IHT) purposes you’re better off leaving as much as you can within your pension, rather than taking it out and having it count as part of your estate.

What about death benefits?

New rules regarding the defined benefit lump sum death benefit (death in service benefits that are written under pensions legislation) and lump sum death benefits when no money has been taken from the pension yet. In these cases, LSADBA rules now apply (see above) which is more beneficial. Before they would have fallen within the old lifetime allowance rules.

Further new rules have been introduced in relation to these are pension protection lump sum death benefit (LSDB), annuity LSDB, drawdown OLSDB and flexi-access drawdown LSDB rules. These are all new rules. Under the old lifetime allowance rules, they wouldn’t have fallen under the lifetime allowance if money had been taken from the pension before the pension holder turned 75. One exception is that if the pension holder died before 5 April this year and had already taken money out of their pension, the sum taken won’t be tested against their LSDBA.

Notably absent from the new rules is beneficiary flexi-access drawdown (BFAD). This remains outside of the new lump sum rules. So, if you die before the age of 75, BFAD is paid to your beneficiary tax-free, whatever the size of your pension. If you die at or after age 75, BFAD is still subject to tax, as it always has been.

What about overseas transfers?

The third and final new lump sum allowance is the overseas transfer allowance (OTA).

The allowance starts the same as the LSDBA (see above) but will also now be used if you transfer benefits to a qualifying recognised overseas pension scheme (QROPS). Your benefits can be transferred tax-free, as long as they are within the allowance, but they will still be taxed at 25% if they go over that. However, be aware that if you used some or all of your lifetime allowance before 6 April this year your OTA will be reduced.

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Tax treatment depends on individual circumstances and all tax rules may change in the future. Withdrawals from a pension product will not be possible until you reach age 55 (57 from 2028). This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.