The new lump sum allowance and lump sum and death benefit allowance

The standard lump sum and death benefit allowance is £1,073,100. This figure will be familiar as the last value of the lifetime allowance. It is fixed and there is no provision for indexation or variation, but individuals with fixed or enhanced protections may benefit from a higher lump sum and death benefit allowance.

The lump sum and death benefit allowance applies when the individual becomes entitled to any of the lump sums (1) to (3) below and on the payment of any of the lump sum death benefits (4) to (9) below.

Each of these occasions is known as a ‘relevant benefit crystallisation event’ (for the purposes of the lump sum and death benefit allowance). The lump sums concerned are:

(1) Pension commencement lump sum;

(2) Serious ill-health lump sum;

(3) Uncrystallised funds pension lump sum;

(4) Annuity protection lump sum death benefit;

(5) Pension protection lump sum death benefit;

(6) Drawdown pension lump sum death benefit;

(7) Flexi-access drawdown lump sum death benefit;

(8) Defined benefits lump sum death benefit; and

(9) Uncrystallised funds lump sum death benefit.

Where the lump sum and death benefit allowance is exceeded (i.e. the aggregate of the tax-free elements of each of the lump sums and lump sum death benefits arising on every relevant benefit crystallisation event occurring after 5 April 2024 exceeds the lump sum and death benefit allowance), the excess is chargeable to income tax at the recipient’s marginal rate.

No event that occurred before 6 April 2024 may be a relevant benefit crystallisation event for the purposes of the lump sum and death benefit allowance. This does not, however, mean that the slate is wiped clean for lump sums and death benefits arising before 6 April 2024 – their value is considered in transitional rules, as with the lump sum allowance.

The same principles apply as for the lump sum allowance in respect of the ‘lifetime allowance previously used amount’ (LAPUA), which is the sum of all the tax-exempt amounts in relation to each (‘old-style’) benefit crystallisation event that occurred before 6 April 2024 and was tested against the individual’s available lifetime allowance.

For all individuals without Enhanced Protection, if LAPUA is equal to or greater than the individual’s lifetime allowance, determined on the same basis as applies in the case of the lump sum allowance, the individual’s available lump sum and death benefit allowance is nil.

If that is not the case, what would otherwise be the individual’s available lump sum and death benefit allowance under the new rules is reduced by the ‘appropriate percentage’ of LAPUA.

The ‘appropriate percentage’ is either 25% or 100%, depending upon the circumstances.

It is 100% if, before 6 April 2024, either:

• The individual became entitled to a serious ill-health lump sum and was under 75 when the lump sum was paid; or
• The individual died while under 75 and a lump sum death benefit was paid in respect of the individual.

In any other case, it is 25%. However, if the individual is one with Primary Protection without lump sum protection, 25% of LAPUA is capped at £375,000.

These rules do not apply if the individual has Enhanced Protection.

The transitional tax-free certificate

To avoid the difficult LAPUA calculation, individuals may apply to their pension scheme to provide them with a ‘transitional tax-free amount certificate’. This will show the individual’s ‘lump sum transitional tax-free amount’ or ‘lump sum and death benefit transitional tax-free amount’ (as the case may be), which is to be deducted from the individual’s available lump sum allowance or lump sum and death benefit allowance – which will be nil if the result of the deduction is a negative amount.

An individual’s lump sum transitional tax-free amount is the total of:

• Each pension commencement lump sum to which the individual became entitled under a registered pension scheme before 6 April 2024; and
• Each uncrystallised funds pension lump sum to which the individual became entitled under a registered pension scheme before 6 April 2024 (disregarding any amounts already taxed under the pensions tax code or under ITEPA 2003 when paid).

An individual’s lump sum and death benefit transitional tax-free amount is the total of:

• Each lump sum to which the individual became entitled under a registered pension scheme before 6 April 2024 if the entitlement gave rise to a benefit crystallisation event (but only to the extent that it was not taxed under the pensions tax code or under ITEPA 2003 when paid); and
• Each lump sum death benefit paid in respect of the individual by a registered pension scheme before 6 April 2024 if the payment gave rise to a benefit crystallisation event (but only to the extent that it was not taxed under the pensions tax code or under ITEPA 2003 when paid).

Conclusion

Despite earlier announcements to the contrary, it seems the lifetime allowance and the lifetime allowance charge will not be reinstated by a Labour Government.

Consequently, it is opportune to come to grips with the new allowances that have replaced the lifetime allowance and how they operate to restrict the tax-free elements of lump sums that may be drawn after 5 April 2024.

It is important to remember, however, that the new rules apply to lump sums entitlement to which arises after 5 April 2024 only, and in the case of lump sum death benefits, to those the rights to which crystallise after 5 April 2024 only.