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Lump Sum Allowance and Lump Sum & Death Benefit Allowance

24/04/2024

Since 6 April 2024, the lifetime allowance has been abolished and replaced by the ‘lump sum allowance’ and ‘lump sum & death benefit allowance’.
For most individuals, the ‘lump sum allowance’, set at £268,275, will be of primary concern. This is because the lump sum allowance is the key limit on the amount of pension fund that can benefit from a 25% tax free cash entitlement when first accessed.

The ‘lump sum & death benefit allowance’, set at £1,073,100, provides a second limit on the amount of tax-free cash available. However, it is of less relevance for tax free cash entitlement, as the lump sum allowance is set lower, so will nearly always be depleted first*.

* the ‘lump sum & death benefit allowance’ could be lower than the ‘lump sum allowance’ in very rare scenarios where a ‘serious ill-health lump sum’ has previously been paid.

Lump Sum & Death Benefit Allowance

As well as limiting tax free cash, the ‘lump sum & death benefit allowance’ also limits the amount that can be paid as a tax-free lump sum on death before 75 or if in serious ill-health (a serious ill-heath lump sum).

Any lump sum death benefit paid is tested against the deceased’s remaining lump sum & death benefit allowance, except in case where it is:

  • A charity lump sum death benefit.
  • A trivial commutation lump sum death benefit. 
  • A lump sum death benefit paid in respect of rights crystallised before 6 April 2024.

In the past, inheriting pension rights on death would not impact on a beneficiary’s own pension allowances. However, where an individual taking beneficiary’s drawdown dies, any relevant lump sum death benefit paid from the fund will now be tested against their remaining ‘lump sum & death benefit allowance’. 

Case study – Joline

Joline (60) has a pension worth £400,000 and decides to retire. She decides to take her maximum tax-free cash entitlement of £100,000 and places the remaining £300,000 into drawdown.
For the purposes of the ‘lump sum allowance’ and ‘lump sum and death benefit allowance’, the £100,000 tax free cash is a relevant benefit crystallisation event. This reduced her allowances by £100,000, as follows:

  • Lump Sum Allowance - reduced from £268,275 to £168,275. 
  • Lump Sum & Death Benefit Allowance – reduced from £1,073,100 to £973,100.

Upon her parent’s death, Joline inherits both her father’s pension valued at £600,000, and later her mother’s pension worth a further £200,000. Both pensions are placed into beneficiary’s drawdown.

After a short illness, Joline dies at age 73. At this point, her own pension is worth £250,000 and her beneficiary drawdown funds are worth £1,000,000. These pensions are divided between her husband and 3 children in equal shares and paid as death benefit lump sums.

These lump sum payments total £1,250,000, which exceeds Joline’s lump sum and death benefit allowance by £276,900 (£1,250,000 - £973,100). The excess of £276,900 will be subject to income tax at the beneficiary’s marginal rate.

To determine how the liability to the income tax charge will be shared between the beneficiaries, Joline’s personal representative(s) can decide the order in which each lump sum payment (relevant benefit crystallisation event) is made. This can allow for the tax liability to be structured in a way that will be most tax efficient for the family.

Comment

The lump sum & death benefit allowance will impact very few individuals. However, it is still important to have a general understanding of how it works.

Funds on death that are designated into beneficiary’s drawdown or annuity are not tested against the lump sum & death benefit allowance. Therefore, for money purchase benefits, it is relatively easy to avoid any resulting tax charge if nominations are in place (allowing a beneficiary to qualify for beneficiary’s drawdown or an annuity). It is important to assess nominations for both inherited pensions as well as those built up by the individual in their own name.

For defined benefit schemes and pension death-in-service benefits, a lump sum payment is often the only option. In this case, an individual’s remaining lump sum & death benefit allowance will always need consideration.

Where an individual wishes to nominate a trust to receive pension death benefits, they may wish to specifically nominate the trust to only receive an amount up to the level of the remaining lump sum & death benefit allowance. They can then nominate individuals to receive any excess under beneficiary’s drawdown and thereby avoid any potential tax charge.

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.