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Lump Sum Allowance and the transitional standard calculation

13/03/2024

In recent months, we have produced several articles covering the abolition of the lifetime allowance and the new pensions rules from 6 April 2024. From this point, the amount of tax-free benefits that can be paid from a pension will be limited to the new ‘lump sum allowance’ of £268,275 and ‘lump sum and death benefit allowance’ of £1,073,100.

For those who crystallised benefits before 6 April 2024, the standard transitional calculation generally assumes that 25% of the previously crystallised funds were taken tax-free, with the new allowances reduced accordingly.

As we have highlighted, any individuals who have not taken as much tax-free cash as the standard calculation assumes have the potential to obtain a ‘transitional tax-free amount certificate’. This can ensure their allowances more fairly reflect the tax-free benefits that they actually took, but the certificate must be obtained before further tax-free cash is taken.

Those over age 75 are one group who may be particularly impacted by these changes.

Case study – Melvin

Melvin (76) is divorced with 2 adult children. At retirement, Melvin had built up significant assets within his estate (ISAs, GIAs, bonds and property), alongside a substantial private pension.

Since his estate would be subject to inheritance tax (IHT) on death, Melvin initially used his non-pension assets to fund his retirement. As his pension won’t be subject to IHT, he felt it made sense to access this later on.

When Melvin turned 75 in March 2023, his pension fund was valued at £800,000. Although he didn’t access any benefits, the fund automatically crystallised at this point under BCE5B.

Under the lifetime allowance system, BCE5 and BCE5B are disregarded when calculating an individual’s maximum tax-free cash entitlement. This meant that Melvin would still be able to take 25% of the fund as tax-free cash at a later date.

Position after 5 April 2024

From 6 April 2024, where individuals have previously ‘crystallised’ pension benefits for Lifetime Allowance (LTA) purposes, the standard transitional calculation assumes that 25% of any crystallised benefits were taken tax-free. This means that the ‘lump sum allowance’ (LSA) and ‘lump sum and death benefit allowance’ (LSDBA) are reduced by 25% of their LTA previously used amount.

As a result, Melvin’s LSA of £268,275 and LSDBA of £1,073,100 will be reduced by £200,000 (25% of £800,000) due to the BCE5B that occurred on his 75th birthday.

Taking tax free cash

Not having a full understanding of the new rules, Melvin decides to access some tax-free cash to purchase a new car. In May 2024, he withdraws tax-free cash of £50,000 and places £150,000 into nil-income drawdown.

Taking the tax-free cash creates a ‘relevant benefit crystallisation event’ (RBCE) and means that Melvin’s remaining LSA is now reduced as follows:

  • £268,275 - £200,000 - £50,000 = £18,275 (remaining LSA).

Although Melvin has only taken £50,000 tax free cash, his remaining tax-free entitlement is now only £18,275. Sadly, since he has had a RBCE after 6 April 2024, he is no longer able to apply for a ‘Transitional Tax-Free Amount Certificate’ (TTFAC) – a TTFAC would have ensured Melvin’s LSA was not reduced by £200,000 (due to the BCE5B) and would have meant he retained his previous tax-free cash entitlement of up to £268,275.

Comment

One group who may be particularly disadvantaged by the new rules are individuals over 75 who haven’t taken all their tax-free cash. These individual’s may find that their remaining tax-free entitlement is greatly reduced after 5 April 2024.

Although the impact of this can usually be mitigated by obtaining a TTFAC, this will not always be possible. In particular, if some tax-free cash was previously taken when the LTA was above £1,073,100, the remaining tax-free entitlement is still likely to be lower even where a TTFAC is obtained.

Furthermore, many affected individuals will not have a good understanding of the new rules and like the example of Melvin, could make irreversible mistakes, meaning a TTFAC application is no longer possible.

HMRC have acknowledged that for those over age 75, this represents a change from the LTA legislation and have stated that they are considering changes to the legislation to resolve this issue.
In the meantime, affected individuals will greatly benefit from having a financial adviser who can help them navigate the new rules and ensure that they can maximise the benefits they are entitled to. 

Important Information

Please note this is for general information only and is based on LV=’s understanding of the relevant legislation and regulations and may be subject to change.

The tax treatment of benefits depends on individual circumstances, and may be subject to change in the future.

The use of this document is at your own risk, and the content should not be used for the provision of professional advice.

LV= accept no liability for any damages, losses or causes of action of any nature arising from your use of this document.