The new pension allowances – some useful examples and case studies

The formal removal of the Lifetime Allowance (LTA) on 6 April 2024 has left advisers, clients, and providers all grappling with new rules and allowances that pension benefits are tested against when clients draw them down.

You have previously read about these new rules, the new limits, and the acronyms that are now in force.

Read on for some case studies that illustrate how these limits will be applied in practice.

Lump Sum Allowance

The Lump Sum Allowance (LSA) is a limit on certain lump sums paid during an individual’s lifetime. The standard LSA is £268,275 for those without transitional protection (equivalent to 25% of the former LTA of £1,073,100).

Where an individual has not previously drawn any benefits before 6 April 2024, the amount of lump sum drawn is tested against the LSA to ensure there is sufficient allowance left to be paid. This will only become an issue if the value of benefits exceeds £1,073,100.

For example, if the value of a client’s benefits is £2 million, the tax-free lump sum available would be limited to £268,275, as opposed to 25% of the full fund value.

Where benefits were drawn before 6 April 2024, matters become a little more complicated. Previous benefit crystallisations need to considered to ascertain the level of LSA available. The following is an example where the standard calculation is used.

Example 1

Howard partially crystallised his SIPP in 2017/18. The amount he crystallised was £400,000, which used up 40% of his LTA and saw him receive a £100,000 pension commencement lump sum.

He now wants to take further benefits from his SIPP, so the standard calculation is carried out to work out the remaining LSA available.

The amount to be deducted is 0.25 x 0.4 x £1,073,100 = £107,310.

So, Howard’s remaining LSA available is £268,275 – £107,310 = £160,965.

However, we have seen that some individuals will benefit from applying for a Transitional Tax-Free Allowance Certificate (TTFAC). This will then see a pension provider be able to use the details on the TTFAC to carry out the alternative calculation.

Example 2

Let’s look at Howard again, discounting the information in the previous example.

Howard took benefits from his employer’s defined benefit scheme in 2017/18. He did not commute any of his benefits into a tax-free lump sum at the time and the LTA calculation saw 80% of the LTA used at the time of the benefit crystallisation.

He now wants to consider taking benefits from his SIPP, which he has been saving into alongside the employer’s scheme. The SIPP is worth £400,000.

Using the standard calculation, the remaining LSA is:

25 x 0.8 x £1,073,100 = £214,620
£268,275 – £214,620 = £53,655 of LSA remaining.

If Howard has a TTFAC, his LSA would not be reduced as he did not take a tax-free lump sum at the time of drawing benefits from his employer’s scheme back in 2017/18.

We can then use the alternative calculation. This sees Howard entitled to a 25% tax-free lump sum from his SIPP (£100,000) and a remaining LSA of £168,275.

There are examples where the normal 25% tax-free lump sum limit does not apply, including:

Primary or enhanced protection with protected tax-free cash
Scheme-specific tax-free cash protection
Serious ill-health lump sum.

It is important to remember that a TTFAC will not result in a more beneficial lump sum position in all instances.

Lump Sum Death Benefit Allowance (LSDBA)

A test on benefits against the LSDBA needs to be taken in the event of death.

As the name suggests, this test is only carried out against death benefits that are being distributed as a lump sum. Consequently, consideration should be given to whether the scheme in question can offer beneficiary drawdown should an individual have accumulated a high level of pension benefits.

The LSDBA position must take into consideration any LSA usage by relevant benefit crystallisation events (RBCEs) that have taken place after 6 April 2024. This is straightforward.

However, matters are more complicated where benefits were drawn before 6 April 2024.

Example 3

Let’s look at Howard again and his earlier benefit crystallisation event (BCE) on his SIPP.

Howard took benefits from his SIPP in 2017/18. The amount he crystallised was £400,000, which used up 40% of his LTA and saw him receive a £100,000 pension commencement lump sum.

Howard died in June 2024. So, using the standard calculation the LSDBA is reduced by 25% of the LTA used in the previous BCE.

The amount to be deducted is 0.25 x 0.4 x £1,073,100 = £107,310.

The remaining LSDBA is £1,073,100 – £107,310 = £965,790.

If Howard, or his legal representatives on death, needed to apply for a TTFAC, then the alternative calculation can be taken into consideration.

Example 4

Again, let us discount the example above for Howard.

Howard died in June 2024 aged 72, but this time he left an uncrystallised SIPP valued at £1.5 million.

Using the standard calculation in this instance, Howard’s remaining LSDBA would be as follows:

£1,073,100 – (0.25 x 0.8 x £1,073,100) = £858,480

Using the alternative calculation, because Howard can evidence through a TTFAC that he did not take any tax-free lump sum on his 2017/18 BCE, the LSDBA is as follows:

£1,073,100 – 0 = £1,073,100

Under the standard calculation, £641,520 of Howard’s SIPP would be subject to tax (£1,500,000 – £858,480).

However, using the alternative calculation, the amount of Howard’s SIPP subject to tax would be reduced to £426,900 (£1,500,000 – £1,073,100).

In this instance, if a TTFAC is applied for by Howard or his representatives after death, an additional £214,620 could be paid out tax-free (£641,520 – £426,900).

The above is based on our understanding of the rules at the time of writing (July 2024) and is subject to change. We will produce further notes should there be any significant updates.

Get in touch

If you want to have a chat about these new allowances and how they may affect your clients, please contact us. Email info@ipm-pensions.co.uk or call 01438 747151.