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

Contributed by Zigurds G Kronbergs FCA FCCA, Senior Technical Writer, Croner-i Ltd

By the time this article is published, it will be the eve of what will perhaps be the most remarkable General Election in living memory. If, as seems increasingly likely, we shall see a Labour Government installed on 5 July, it will be faced with how to balance promises not to increase income tax, National Insurance contributions or VAT with the pressing need to raise revenue to fill the gap the Institute for Fiscal Studies and other independent experts claim exists between campaign pledges and the sources of finance the party has already identified.

One area where the new Government (even a returned Conservative Government) is bound to look is pensions taxation. One policy that may well suggest itself to Rachel Reeves (if it is she at No. 11) is restriction of relief for pension contributions to the basic rate of tax. Be that as it may, what we have learned during the campaign is that Labour’s promise immediately to restore the lifetime allowance and the lifetime allowance charge abolished by Jeremy Hunt as from 6 April this year will not be carried out if at all, let alone immediately. This therefore seems an appropriate moment to examine the two allowances (limits, really) introduced by  Finance Act 2024  to replace the lifetime allowance. These are the lump sum allowance and the lump sum and death benefit allowance.

The lump sum allowance

For 2024–25 onwards, subject to transitional provisions, there are new limits on tax-free lump sums that may be taken from existing arrangements. Following the abolition of the lifetime allowance, the taking of a pension is no longer an event that may trigger a special tax charge. Pensions, no matter their amount, and no matter how many pension benefits have been taken previously, remain taxable at the pensioner’s marginal rate of tax. The position is different with lump sums.

Unlike the earnings limit and the annual allowance, but like the former lifetime allowance, neither the lump sum allowance nor the lump sum and death benefit allowance has effect in relation to a tax year, but represents a lifetime limit on the total tax-free lump sums that an individual may receive from all the registered pension schemes of which the individual is a member and on the tax-free lump sum death benefits that may be paid to the individual’s beneficiaries after the individual has died.

The standard lump sum allowance is £268,275. This figure will be familiar as 25% of the last value of the lifetime allowance. It is fixed and there is no provision for indexation or variation, but individuals with Primary Protection and certain enhancements may benefit from a higher lump sum allowance. How protections and enhancements have effect in the new post-5 April 2024 dispensation will be the subject of future articles.

The lump sum allowance comes into play when the individual becomes entitled to:

• a pension commencement lump sum; or
• an uncrystallised funds pension lump sum

and to no other lump sums.

Another way of saying this might be that it is only these two lump sums that are tested against the lump sum allowance.

The legislation refers to these two events as ‘relevant benefit crystallisation events’, echoing the former benefit crystallisation events that were tested against the lifetime allowance. Confusingly, however, the same term is used to refer to the greater number of events that are tested against the lump sum and death benefit allowance (see below). One always has to specify which of either set of relevant benefit crystallisation events is meant, therefore.

Where the lump sum allowance is exceeded (i.e. the aggregate of the tax-free elements of previous pension commencement lump sums and uncrystallised funds pension lump sums to which entitlement arises after 5 April 2024 exceeds the individual’s lump sum 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 allowance. This does not, however, mean that the slate is wiped clean for lump sums that arose before 6 April 2024 – their value is taken into account in transitional rules.

Events that occur before 6 April 2024 are also taken into account when testing a relevant benefit crystallisation event that occurs on or after 6 April 2024 against the lump sum allowance, but for two classes of individual only, namely:

(1)individuals without Enhanced Protection and individuals with Enhanced Protection but without lump sum protection;

(2)certain individuals with Primary Protection but without lump sum protection.

Broadly, for these two classes of individual, if the individual had used up all or part of his or her lifetime allowance on the occurrence of one or more (‘old-style’) benefit crystallisation events (BCEs) before 6 April 2024, the rules look at how much of the individual’s lifetime allowance would have been used up on the assumption that all those BCEs had occurred on 5 April 2024. The amount that would have been so used up is known as the ‘lifetime allowance previously-used amount’ (LAPUA).

For the first class of individual (those without Enhanced Protection or those with Enhanced Protection but without lump sum protection), when a relevant benefit crystallisation event occurs on or after 6 April 2024, what would otherwise be the individual’s available lump sum allowance under the new rules is reduced by 25% of LAPUA. If the result is negative, the available lump sum allowance is nil.

For the second class of individual (those with Primary Protection but without lump sum protection), 25% of LAPUA is capped at £375,000.

These rules do not apply if the individual has Enhanced Protection with lump sum protection.

Lump sums may also need to be tested against the available lump sum and death benefit allowance (see below).

The 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 taken into account 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 t